COMPOUND
INTEREST
Objectives:
At the end of the lesson:
a) The learner is able to compute interest, maturity
value, and present value in compound interest
environment, and
b) Solve problems involving compound interest.
What is Compound Interest?
Compound Interest
Compound interest refers to the phenomenon
whereby the interest associated with a bank account,
loan, or investment increases exponentially—rather than
linearly—over time. The key to understanding the
concept is the word “compound.”
Maturity (Future Value) Formula:
F= P(𝟏 + 𝒓)𝒕
Where:
P = principal or present value
F= maturity (future) value at the end of the term
r= interest rate
t= term/time in years
The compound interest Ic is given by
Ic = F − P
Example:
Find the maturity value and the compound interest if P10,000 is compounded
annually at an interest rate of 2% in 5 years.
Given:
P= 10,000 r= 2% or 0.02 t=5 years
Find:
(a) Maturity value F
(b) Compound interest Ic
Solution:
(a) F = P(1 + 𝑟)𝑡
F= (10,000)(1 + 0.02)5
F= 11,040.81
(b) Ic = F − P
Ic=11,040.81-10,000
Ic=1,040.81
Answer: The future value F is P11,040.81 and the compound interest is
P1,040.81
Example:
Find the maturity value and the compound interest if P50,000 is invested at
5% compounded annually for 8 years.
Given:
P= 50,000 r=5% or 0.05 t=8 years
Find:
(a) Maturity value F
(b) Compound interest Ic
Solution:
(a) F= P(1 + 𝑟)𝑡
F= (50,000)(1 + 0.05)8
F= 73,872.77
(b) Ic = F-P
Ic= 73,872.77 -50,000
Ic=23,872.77
Answer: The future value F is P 73,872.77 and the compound interest
is P 23,872.77
Present Value P at Compound Interest
𝐹
𝑃= 𝑡
= F(1 + 𝑟)−𝑡
(1 + 𝑟)
Where:
P is the principal or present value.
F is the maturity (future) value at the end of the term.
r is the interest rate
t is the term or time in years
Example:
What is the present value of P50,000 due in 7 years if money is worth 10%
compounded annually?
Given:
F= 50,000 r=10% or 0.1 t=7 years
Find:
(a) Present value P
Solution:
𝐹
𝑃=
(1+𝑟)𝑡
50,000
𝑃=
(1+0.1)7
𝑃 = 25,657.91
Answer: The present value is P25,657.91
Compounding More than Once a Year
Formula:
𝒓 𝒏𝒕
𝑭=𝑷 𝟏+
𝒏
Where:
F is the future value (principal + interest).
r is the yearly interest rate in decimal point.
n is the number of times per year the interest is compounded.
t is the term of the investment in years.
Example:
Find the maturity value and interest if P10,000 is deposited in a bank at 2%
compounded quarterly for 5 years.
Given:
P= 10,000 r = 2% or 0.02 t = 5 years n=4
Find:
(a) Maturity value F
(b) Compound interest Ic
Solution:
𝒓 𝒏𝒕
𝑭=𝑷 𝟏+
𝒏
𝟒 𝟓
𝟎. 𝟎𝟐
𝑭 = 𝟏𝟎, 𝟎𝟎𝟎 𝟏+
𝟒
𝑭 = 𝟏𝟏, 𝟎𝟒𝟖. 𝟗𝟔
𝑰=𝑭−𝑷
𝑰 = 𝟏𝟏, 𝟎𝟒𝟖. 𝟗𝟔 − 𝟏𝟎, 𝟎𝟎𝟎
𝑰 = 𝟏, 𝟎𝟒𝟖. 𝟗𝟔
Answer: The future value F is P11,048.96 and the compound interest is P1,048.96
Present Value P at Compound Interest
F
P= 𝐧𝐭
𝐫
𝟏+
𝐧
Where:
P = principal or present value
F = maturity (future) value at the end of the term
r = interest rate
t = term/time in years
n is the number of times per year the interest is compounded
Example:
Find the present value of ₱50,000 due in 4 years if
money is invested at 12% compounded semi-annually.
Given: F = 50,000 r = 12% = 0.12 t = 4 years n=2
Find: P
𝐹
𝑃= nt
r
1+
n
50,000
P= (2)(4)
0.12
1+
2
𝑷 = 𝟑𝟏, 𝟑𝟕𝟎. 𝟔𝟐
Answer: The present value at Compound Interest is ₱ 𝟑𝟏, 𝟑𝟕𝟎. 𝟔𝟐
Finding Time in Compound Interest
Example:
If you want to save $5,000 before buying your first new car,
and you have $3,000 right now to invest at a 3% interest
compounded monthly, how long will you have to wait?
Given: F = $5,000 r = 3% = 0.03 n = 12
Find: t
𝑟 𝑛𝑡
𝐹 =𝑃 1+
𝑛
12𝑡
0.03
5,000 = 3,000 1 +
12
𝑡 ≈ 17 Answer: Better figure out a way to save
more money unless you’re okay with
waiting for 17 years.
Solution:
𝑭
𝐥𝐨𝐠
t= 𝒓
𝐥𝐨𝐠(𝟏+ )
𝑷
÷ 𝒏 log
5
3
𝒏 t= .03 ÷ 12
log(1+ )
12
t = 17.04879634 ≈ 17
What Is an Effective Annual Interest Rate?
An effective annual interest rate is the real return on a
savings account or any interest-paying investment when the
effects of compounding over time are taken into account. It
also reflects the real percentage rate owed in interest on a
loan, a credit card, or any other debt.
Finding Effective Interest Rate
Example:
Find the effective interest rate when the stated rate is 4% and the
interest is compounded weekly, then describe what your result means.
Let r = 0.04 (rate is 4%) and n = 52 (compounded weekly) and then substitute
into the formula.
𝒓 𝒏
𝑬= 𝟏+ −𝟏
𝒏
𝟎.𝟎𝟒 𝟓𝟐
= 𝟏+ −𝟏
𝟓𝟐
The effective rate is 4.08%. This tells us
≈ 𝟎. 𝟎𝟒𝟎𝟖 = 𝟒. 𝟎𝟖% that an account at 4% compounded
weekly will earn the same amount of
interest in 1 year as a simple interest
account at 4.08%
Comparing the Effective Rate of Two Investments
Example:
Which savings account is a better investment: 6.2% compounded
daily or 6.25% compounded semiannually?
Find the effective rates of both account and compare them
6.2% daily 6.25% semiannually
r = 0.062, n = 365 r = 0.0625, n = 2
𝒓 𝒏 𝒓 𝒏
𝑬= 𝟏+ −𝟏 𝑬= 𝟏+ −𝟏
𝒏 𝒏
= 𝟏. 𝟎𝟔𝟑𝟒𝟕 − 𝟏
𝟎.𝟔𝟐 𝟑𝟔𝟓
= 𝟏 + 𝟑𝟔𝟓 −𝟏
≈ 𝟎. 𝟎𝟔𝟑𝟓 = 𝟔. 𝟑𝟓%
= 𝟏. 𝟎𝟔𝟑𝟗𝟓 − 𝟏
≈ 𝟎. 𝟎𝟔𝟒𝟎 = 𝟔. 𝟒𝟎%
The 6.2% daily investment has a slightly better effective rate than 6.25% semiannually.
COMPOUND INTEREST 4.
(use yellow pad paper, copy the The principal that amounts to PhP 4913 in 3 years at 6¹/₄ % per
problem, show the solution) annum compound interest, compounded annually, is ___.
(a) PhP 3096
(b) PhP 4076
1. The compound interest on PhP 50000 at 8
(c) PhP 4085
% per annum for 2 years, compounded
(d) PhP 4096
annually, is ___.
(a) PhP 8000
5.
(b) PhP 8250
If the simple interest on a sum of money at 5% per annum for 3
(c) PhP 8350
years is PhP 1200, then the compound interest on the same sum
(d) PhP 8640
for the same period at the same rate will be ___.
(a) PhP 1225
2. At what rate per cent per annum will a sum
(b) PhP 1236
of PhP 7500 amount to PhP 8427 in 2 years,
(c) PhP 1248
compounded annually?
(d) PhP 1261
(a) 4 %
(b) 5 %
6.
(c) 6 %
A certain sum of money gives PhP 510 as compound interest
(d) 8 %
12¹/₂ % per annum for 2 years. Find the simple interest on the
3. Ben deposits PhP 30000 in a bank at 7% per
same sum of money at the same rate for the same period of
annum compound interest for a certain time is
time.
PhP 4347. The time is __.
(a) PhP 400
(a) 2 years
(b) PhP 450
(b) 2¹/₂ years
(c) PhP 460
(c) 3 years
(d) PhP 480
(d) 4 years
7. 9.
On a sum of PhP 15000 for 2 years, if the difference You lend out PhP5500 at 10% compounded
between compound interest and simple interest is PhP monthly. If the debt is repaid in 18 months,
96. Find the rate of interest per cent per annum. what is the total owed at the time of
(a) 6 repayment?
(b) 8 a) PhP 2,145.16
(c) 10 b) PhP 3,875.34
(d) 12 c) PhP 6, 386.12
d) PhP 3,586.11
8.
What principal will amount to PhP 1750 if invested at 10.
3% interest compounded quarterly for 5 years? What principal will amount to PhP 2000 if
a) PhP 1507.08 invested at 4% interest compounded semi-
b) PhP 2,143 annually for 5 years?
c) PhP 4,549.75 a) PhP 1,640.70
d) PhP 2, 156 b) PhP 1,287.54
c) PhP 1, 534
d) PhP 1, 489
