Professional Documents
Culture Documents
Compound Interest Notes
Compound Interest Notes
WhatisCompoundInterest?
Ifyouwalkintoabankandopenupasavingsaccountyouwillearninterestonthemoneyyoudepositin
thebank.Iftheinterestiscalculatedonceayearthentheinterestiscalledsimpleinterest.Iftheinterestis
calculatedmorethanonceperyear,thenitiscalledcompoundinterest.
CompoundInterestFormula
Themathematicalformulaforcalculatingcompoundinterestdependsonseveralfactors.Thesefactors
includetheamountofmoneydepositedcalledtheprincipal,theannualinterestrate(indecimalform),the
numberoftimesthemoneyiscompoundedperyear,andthenumberofyearsthemoneyisleftinthebank.
Thesefactorsleadtotheformula
FV=futurevalueofthedeposit
P=principaloramountofmoneydeposited
r=annualinterestrate(indecimalform)
n=numberoftimescompoundedperyear
t=timeinyears.
n t
FV = P 1+
n
SolvingCompoundInterestProblems
Tosolvecompoundinterestproblems,weneedtotakethegiveninformationatplugtheinformationintothe
compoundinterestformulaandsolveforthemissingvariable.Themethodusedtosolvetheproblemwill
dependonwhatwearetryingtofind.Ifwearesolvingforthetime,t,thenwewillneedtouselogarithms
becausethecompoundinterestformulaisanexponentialequationandsolvingexponentialequationswith
differentbasesrequirestheuseoflogarithms.
ExamplesNowletssolveafewcompoundinterestproblems.
Example1:Ifyoudeposit$4000intoanaccountpaying6%annualinterestcompoundedquarterly,how
muchmoneywillbeintheaccountafter5years?
4(5)
0.06
FV = 4000 1+
Pluginthegivinginformation,P=4000,r=0.06,n=4,
andt=5.
FV = 4000(1.015)20
FV = 4000(1.346855007)
Usetheorderoroperationstosimplifytheproblem.Ifthe
problemhasdecimals,keepasmanydecimalsaspossible
untilthefinalstep.
FV=5387.42
Roundyourfinalanswertotwodecimalsplaces.
After5yearstherewillbe$5387.42intheaccount.
Example2:Ifyoudeposit$6500intoanaccountpaying8%annualinterestcompoundedmonthly,how
muchmoneywillbeintheaccountafter7years?
12(7)
0.08
FV = 6500 1+
12
Pluginthegivinginformation,P=6500,r=0.08,n=12,
andt=7.
FV = 6500(1.00666666)84
FV =6500(1.747422051)
Usetheorderoroperationstosimplifytheproblem.Ifthe
problemhasdecimals,keepasmanydecimalsaspossible
untilthefinalstep.
FV=11358.24
Roundyourfinalanswertotwodecimalsplaces.
After7yearstherewillbe$11358.24intheaccount.
Example3:Howmuchmoneywouldyouneedtodeposittoday at9%annualinterestcompoundedmonthly
tohave$12000intheaccountafter6years?
12(6)
0.09
12000 = P 1+
12
Pluginthegivinginformation,FV=12000,r=0.09,n=
12,andt=6.
12000 = P(1.0075)72
Usetheorderoroperationstosimplifytheproblem.Ifthe
problemhasdecimals,keepasmanydecimalsaspossible
untilthefinalstep.
12000 = P(1.712552707)
P=7007.08
Divideandroundyourfinalanswertotwodecimals
places.
Youwouldneedtodeposit$7007.08tohave$12000in6years.
Inthelast3exampleswesolvedforeitherFVorPandwhensolvingforFVorPismostlyacalculator
exercise.Becarefulnottotryandtypetoomuchintothecalculatorinonestepandletthecalculator
storeasmanydecimalsaspossible.Donotroundofftoosoonbecauseyouranswermaybeslightlyoff
andwhendealingwithmoneypeoplewanteverycenttheydeserve.
Inthenext3exampleswewillbesolvingfortime,t.Whensolvingfortime,wewillneedtosolve
exponentialequationswithdifferentbases.Rememberthattosolveexponentialequationswith
differentbaseswewillneedtotakethecommonlogarithmornaturallogarithmofeachside.Taking
thelogarithmofeachsidewillallowustouseProperty5andrewritetheproblemasamultiplication
problem.Oncetheproblemisrewrittenasamultiplicationproblemweshouldbeabletosolvethe
problem.
Example4:Ifyoudeposit$5000intoanaccountpaying6%annualinterestcompoundedmonthly,how
longuntilthereis$8000intheaccount?
12t
0.06
8000 = 5000 1+
12
Pluginthegivinginformation,FV=8000,P=5000,r=
0.06,andn =12.
8000 =5000(1.005)12t
Usetheorderoroperationstosimplifytheproblem.Keep
asmanydecimalsaspossibleuntilthefinalstep.
1.6 =1.00512t
Divideeachsideby5000.
log(1.6) = log(1.00512t)
Takethelogarithmofeachside.ThenuseProperty5to
rewritetheproblemasmultiplication.
log1.6 =(12t)(log1.005)
log1.6
=12t
log1.005
Divideeachsidebylog1.005.
94.2355323212t
Useacalculatortofindlog1.6dividedbylog1.005.
t7.9
Finishsolvingtheproblembydividingeachsideby 12
androundyourfinalanswer.
Itwilltakeapproximately7.9yearsfortheaccounttogofrom$5000to$8000.
Example5:Ifyoudeposit$8000intoanaccountpaying7%annualinterestcompoundedquarterly,how
longuntilthereis$12400intheaccount?
4t
0.07
12400 = 8000 1+
Pluginthegivinginformation,FV=12400,P=8000,r=
0.07,andn =4.
12400 =8000(1.0175) 4t
Usetheorderoroperationstosimplifytheproblem.Keep
asmanydecimalsaspossibleuntilthefinalstep.
1.55 =1.0175 4t
Divideeachsideby 8000.
log(1.55) = log(1.01754t)
Takethelogarithmofeachside.ThenuseProperty5to
rewritetheproblemasmultiplication.
log1.55 =(4t)(log1.0175)
log1.55
= 4t
log1.0175
Divideeachsidebylog1.0175.
25.261632794t
Useacalculatortofindlog1.55dividedbylog1.0175.
t6.3
Finishsolvingtheproblembydividingeachsideby 4and
roundyourfinalanswer.
Itwilltakeapproximately6.3yearsfortheaccounttogofrom$8000to$12400.
Example6:At3%annualinterestcompoundedmonthly,howlongwillittaketodoubleyourmoney?
Atfirstglanceitmightseemthatthisproblemcannotbesolvedbecausewedonothaveenough
information.Itcanbesolvedaslongasyoudoublewhateveramountyoustartwith.Ifwestartwith
$100,thenP=$100andFV=$200.
12t
0.03
200 = 100 1+
12
Pluginthegivinginformation,FV=200,P=100, r=
0.03,andn =12.
200 =100(1.0025)12t
Usetheorderoroperationstosimplifytheproblem.Keep
asmanydecimalsaspossibleuntilthefinalstep.
2 =1.0025 12t
Divideeachsideby 100.
Takethelogarithmofeachside.ThenuseProperty5to
rewritetheproblemasmultiplication.
log 2 =(12t)(log1.0025)
log 2
= 12t
log1.0025
Divideeachsidebylog1.0025.
277.605301612t
Useacalculatortofindlog2dividedbylog1.0025.
t23.1
Finishsolvingtheproblembydividingeachsideby 12
androundyourfinalanswer.
At3%annualinterestitwilltakeapproximately23.1yearstodoubleyourmoney.
AdditionExamples
Ifyouwouldliketoseemoreexamplesofsolvingcompoundinterestproblems,justclickonthelinkbelow.
AdditionalExamples
PracticeProblems
Nowitisyourturntotryafewpracticeproblemsonyourown.Workoneachoftheproblemsbelowand
thenclickonthelinkattheendtocheckyouranswers.
Problem1:Ifyoudeposit$4500at5%annualinterestcompoundedquarterly,howmuchmoneywillbein
theaccountafter10years?
Problem2:Ifyoudeposit$4000intoanaccountpaying9%annualinterestcompoundedmonthly,how
longuntilthereis$10000intheaccount?
Problem 3:Ifyoudeposit$2500intoanaccountpaying11%annualinterestcompoundedquarterly,how
longuntilthereis$4500intheaccount?
Problem 4:Howmuchmoneywouldyouneedtodeposittodayat5%annualinterestcompoundedmonthly
tohave$20000intheaccountafter9years?
Problem5:Ifyoudeposit$6000intoanaccountpaying6.5%annualinterestcompoundedquarterly,how
longuntilthereis$12600intheaccount?
Problem6:Ifyoudeposit$5000intoanaccountpaying8.25%annualinterestcompoundedsemiannually,
howlonguntilthereis$9350intheaccount?
SolutionstoPracticeProblems