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INTEREST
- is the amount of money paid for the use of borrowed
capital or the income produced by money which has
been loaned

INTEREST
Engr. Charity Hope Gayatin

PROBLEMS
1. Find the missing value
1. SIMPLE INTEREST- calculated using the principal
only, ignoring any interest that had been accrued in
preceding periods P = P20,500 r = 4 1/2% n = 3yrs
I = Pin
I – interest P = P19,350.75 I = P4,500 n = 2yrs
P – present worth
n – number of interest period P = P5,250 I = P775 r = 9 3/4%
i – rate of interest per interest period
I = P5,630 r = 8 1/4% n = 4yrs & 6mos

2. Compute for the simple interest and the 4. Mr. ABCD obtained a loan of P45,000 from Pag-
amount on a P15,000 salary loan at 12% simple interest ibig at 15% interest rate. When was the loan due if he
for 3years. paid P68,000 on the maturity date?

3. If Mrs. ABCD paid an interest of P4,259 for a 5. Ms. ABCD borrowed P80,000 in a cooperative.
bank loan payable in 2 and a half years at 15% per She paid an interest of P2,500 for 11months. At what
annum, how much was the original loan? rate is the interest charged?

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TIME BETWEEN 2 DATES
EXACT TIME- is determined by counting each day of
each month of the term except the origin date.
APPROXIMATE TIME- is determined by assuming each
month to have 30days and then counting each day
of each month except the origin date.
BANKER’S RULE- uses the exact time / 360
2. Find the actual number of days between
a) February 14 to May 11, 2009
b) October 1 to Dec 25, 2008
PROBLEMS
1. Determine the ordinary simple interest on P7,000
for 8 months and 15 days if the rate of interest 15%.
2. Determine the exact simple interest of P15,000
for the period of January 10 to October 28, 2012 at
16% interest.
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PROBLEMS
1. Find the approximate number of days between
a) February 14 to May 11, 2009
b) October 1 to Dec 25, 2008
a) ORDINARY SIMPLE INTEREST- computed on the
basis of 12 months of 30 days each or 360 days a year
b) EXACT SIMPLE INTEREST- based on the exact
number of days in a year, 365 days for ordinary year
and 366 days for leap year
ACCUMULATION AT SIMPLE INTEREST
The Principal, P accumulates to the value F, Future
Amount at the end of n years.
P refers to the discounted value of F on the day which
is n years before the due date of F.
The current value of a future amount is the present
value of a loan or investment.
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PROBLEMS
F  P  I  P (1  in)
1. If the money is worth 14% simple interest which is
F due in 6years, what is the amount of a P250,000 loan?
P 
(1  in ) 2. Discount P45,310 at 11.5% simple interest for
175days.

P– present worth
i – interest
F– future worth

5. Ms. ABCD borrowed P20,500 from Mr. EFGH at

20% simple interest. She promised to pay the principal
and the corresponding interest on October 13, 2009. If
3. Accumulate P70,000 at 13.5% simple interest for the loan was made last January 2, 2008, how much is
2years and 10months.
a) the interest on the loan?
4. What sum will accumulate to P72,000 in 8years
at 12.45% simple interest? b) the amount Mr. EFGH would receive on
October 13, 2009?

Introduction
 Re-investing your interest income from an
investment makes your money grow faster over
Compound time! This is what compound interest does.
 Compound interest uses the same information
Interest as simple interest, but what is new is the
Engr. Charity Hope Gayatin
frequency of compounding n.
 n=1 annual, n=2 semi-annual, n=4 quarterly,
n=12 monthly, n=52 weekly, n=365 daily.

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COMPOUND INTEREST - is the interest for an

interest period is calculated on the principal plus NOMINAL RATE OF INTEREST - specifies the rate
total amount of interest accumulated in previous of interest and a number of interest periods in
periods one year

Single payment at i present interest compound i=r/m

amount in n interest period factor
n
F  P(1  i ) , F / P, i %, n i - rate of interest per interest period
r - nominal interest rate
Single payment present worth m - number of compounding periods
n per year
P  F (1  i ) , P / F, i %, n

EFFECTIVE RATE OF INTEREST - exact rate of interest

on the principal during one year
Compound Interest Formula
 If P represents the present value, r the annual
( 1 + r / m) m – 1 interest rate, n the time in years, and m the
frequency of compounding, then the future
value is given by the formula:

F = P( 1 + r/m)mn

Example
 Suppose you invest $32,000 into a certificate of
deposit that has an annual interest rate of 5.2%
compounded annually for 3 years. Determine its
accrued value.
Example
 Suppose you invest $32,000 into a certificate of
deposit that has an annual interest rate of 5.2%
compounded annually for 3 years. Determine its
accrued value.
 ANSWER: Use the compound interest formula.
 F = 32000(1+.052/4)(4)(3) = 32000(1.013)12
= $37,364.86

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Annual Yield
 To compare different savings plans, you
need to have a common basis for making
the comparisons.
 The annual yield of a compound interest
investment is the simple interest rate that has
the same future value the compound rate
would have in one year.
Example yield calculation
 Find the annual yield for an investment
that has an annual interest rate of 8.4%
compounded monthly.
 The yield will usually be greater than the
interest rate.
 Note the interest rate is sometimes called
the nominal interest rate.
Continuous Compounded
Interest
 What would happen if we let the
frequency of compounding get very large.
That is we would compound not just every
hour, or every minute or every second but
for every millisecond!
 What happens is that the expression (1
+r/m)mn goes to ern. This e is the famous
Euler number. It’s value is the irrational
number 2.7182818 …
 The future value formula is F = Pern.
 The annual yield for continuously
compounded interest is i = er – 1.
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Derivation of yield
• Future Value Compound = Future value
simple
• P(1 + r/m)mn = P(1 + in)
• Since this computation is done for 1 year,
we set n = 1.
• P(1+ r/m)m = P(1 + i)
• Since P appears on both side, we divide
by P and P disappears.
• (1 + r/m)m = 1 + i, now solve for i by
subtracting 1 from both sides.
• The formula for yield is i = (1 + r/m)m – 1.
Example yield calculation
 Find the annual yield for an investment
that has an annual interest rate of 8.4%
compounded monthly.
 ANSWER: y = (1 + .084/12)12 – 1
 y = (1.007)12 – 1 = 0.087310661 = 8.73%
 The yield will usually be greater than the
interest rate.
 Note the interest rate is sometimes called
the nominal interest rate.
Example of Continuous
Compound interest.
 Consider the $32,000 from the earlier
example. Now we will invest the money
in an account that has 5.2% annual
interest compounded continuously for
3 years. What is the future value? What
is the yield for this investment?
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Example of Continuous
Compound interest.
 Consider the $32,000 from the earlier
example. Now we will invest the money in
an account that has 5.2% annual interest
compounded continuously for 3 years.
What is the future value?
 ANSWER: F = 32000e(.052)(3) = $37,402.44 DISCOUNT
Engr. Charity Hope Gayatin
 Note this investment option is only greater
by $37.58.
 What is the yield for this investment?
 ANSWER: y = e.052 – 1 = 0.05337 = 5.34%

Learning Unit Objectives Structure of a Promissory Note

Structure of Promissory Notes; the Simple Discount Note

1. Calculate bank discount and proceeds for simple discount notes.
2. Calculate and compare the interest, maturity value, proceeds, and
effective rate of a simple interest note with a simple discount note.

Finding the Face Value, Rate, and Time for a Simple Interest Note and a
Simple Discount Note
1. Find the face value (principal), rate, and time of a simple interest
note.
2. Find the face value (maturity value), bank discount rate, and time of
a simple discount note.

Simple Discount Note Terminology Simple Discount Note

Simple Discount Note -- A note in which the loan interest is deducted in
advance.
Pete Runnels has a choice of two different notes that both have a face
Bank Discount -- The interest that banks deduct in advance.
value (principal) of $14,000 for 60 days. One note has a simple interest
Maturity Value – The total amount due at the end of the loan (the sum of the rate of 8%, while the other note has a simple discount rate of 8%. For
each type of note, calculate
face value, or principal, and interest).
a) interest owed,
Proceeds -- The amount the borrower receives after the bank deducts its
discount from the loan’s maturity value. b) maturity value,
c) proceeds, and
Bank Discount Rate -- The percent of interest.
d) effective rate:

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Simple Interest & Simple Discount

Simple Interest Simple Discount

Interest Owed Interest Owed

I = Pin D = Fdt
= Principal * Interest Rate * Time = Maturity Value * Discount Rate * Time
Maturity Value Maturity Value
F =P+I F = FV
= Principal + Interest = Face Value
Proceeds Proceeds EQUATION of VALUE
Engr. Charity Hope Gayatin
P = FV P =F −D
= Face Value = Maturity Value − Discount
Effective Rate Effective Rate
I D
ER = ER =
P∗n P∗n
Interest Interest
= =
Principal∗Time Proceeds∗Time

Cash Flow Cash Flow

Example
A mechanical device will cost $20,000 when purchased. Maintenance
Cash Flow is the sum of money recorded as will cost $1,000 per year. The device will generate revenues of $5,000
receipts or disbursements in a project’s per year for 5 years. The salvage value is $7,000.
financial records.
A cash flow diagram presents the flow of
cash as arrows on a time line scaled to the
magnitude of the cash flow, where expenses
are down arrows and receipts are up arrows.

Economic Equivalence and Equation of Value Discount Factors and Equivalence

Economic Equivalence is the process of comparing two different cash
amounts at different point in time.
Economic Equivalence exists between cash flows that have the same
economic effect and could be traded for one another in the financial
marketplace, which we assume to exist.
Present Worth (P) – Present Amount at t = 0
Future Worth (F) – Equivalent Future Amount at t = n of any present
amount at t = 0
Annual Amount (A) – Uniform Amount that repeats at the end of
each years for n years

Economic equivalence refers to the fact that a cash flow – whether a Uniform Gradient Amount (G) – Uniform Gradient Amount that
single payment or a series of payments – can be converted to an repeats at the end of each year, starting at the end of the second year
equivalent cash flow at any point in time. For example, we could find and stopping at the end of year n
the equivalent future value F of a present amount P at interest I at
period n; or we could determine the equivalent present value P of N
equal payments A.
Equation of Value is obtained by setting the sum of the values on a
certain comparison or focal date of one set of obligations equal to the
sum of the values on the same date of another set of obligations

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Discount Factors and Equivalence
Equivalence
Example
A man bought a lot worth P1million if paid in cash. On installment
basis, he paid a down payment of P200,000, P300,000 at the end of
1year, P400,000 at the end of 3years and a final payment at the end of
5years. What was the final payment if interest was 20%?
Learning Outcome
Derive and use factors for uniform series - present worth (P/A) and
capital recovery factors (A/P)
Derive and use factors for uniform series – compound amount (F/A)
and sinking fund (A/F)
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Equivalence Calculations General Principles
1. Equivalence calculations made to compare alternatives require a
common time basis – equivalent cash flows are equivalent at any
common point in time
2. Equivalence depends on interest rate – changing the interest rate
destroys equivalence
3. Equivalence calculations may require the conversion of multiple
payment cash flows to a single cash flow – Equivalence
calculations with multiple payments
4. Equivalence is maintained regardless of point of view
ANNUITIES
Engr. Charity Hope Gayatin
Annuities
ANNUITY are series of equal payments occurring at equal periods of
time
ORDINARY ANNUITY are series of equal payments made at the end of
each period
DEFERRED ANNUITY are series of equal payments where the first
payment is made several periods after the beginning of the annuity
PERPETUITY are series of equal payments in which the payments
continue indefinitely
P=A/i
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Uniform Series Present Worth (P/A) and Uniform Series Present Worth (P/A) and
Capital Recovery Factor (A/P) Capital Recovery Factor (A/P)
The Uniform Series Present Worth Factor (P/A) is used to calculate the
equivalent P value in year 0 for a uniform end-of-period series of A
values beginning at the end period 1 and extending for n periods.
The Capital Recovery Factor (A/P) is used to calculate the equivalent
uniform annual worth A over n years for a given P in year 0, when the
interest rate is i.

Uniform Series Present Worth (P/A) and Sinking Fund Factor (A/F) and Uniform Series
Capital Recovery Factor (A/P) Compound Amount Factor (F/A)
The Sinking Fund Factor (A/F) determines the uniform annual series A
that is equivalent to a given future amount F. The uniform series A
begins at the end of year (period) 1 and continues through the year of
the given F. The last A value and F occur at the same time.
The Uniform Series Compound Amount Factor (F/A) is used to yield
the future worth of the uniform series. The future amount F occurs in
the same period as the last A.

Sinking Fund Factor (A/F) and Uniform Series Sinking Fund Factor (A/F) and Uniform Series
Compound Amount Factor (F/A) Compound Amount Factor (F/A)

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Problem
1. What are the present worth and the accumulated amount of a 10 year
annuity paying P10000 at the end of each year, with interest at 15%
compounded annually?

2. On the day his grand son was born, a man deposited to a trust
company a sufficient amount of money so that the boy could receive 5
annual payments of P10000 each for his college tuition fees, starting
with his 18th birthday. Interest at the rate of 12% per annum was to be
paid on all amounts on deposit. There was also a provision that the
grandson could elect to withdraw no annual payments and receive a
single lump amount on his 25th birthday. The grandson chose this GRADIENT
Engr. Charity Hope Gayatin
option.
a) How much did the boy receive as single payment?
b) How much did the grandfather deposit?

3. What amount of money invested today at 15% interest can provide the
following scholarship: P30000 at the end of each year for 6 years,
P40000 for the next 6 years and P50000 thereafter?

Learning Outcome Arithmetic Gradient Factors (P/G and A/G)

An Arithmetic Gradient Series is a cash flow series that either increases
or decreases by a constant amount each period. The amount of
Use the present worth (P/G) and uniform annual series (A/G) factors change is called the Gradient.
for arithmetic gradient
Use the geometric gradient series factor (P/A, g) to find the present
worth

It is important to realize that the base amount defines a uniform cash

flow series of the size A that occurs each time period.

Arithmetic Gradient Factors (P/G and A/G) Arithmetic Gradient Factors (P/G and A/G)
If the base amount is ignored, a generalized arithmetic (increasing)
gradient cash flow diagram is as shown in the figure. Note that the
gradient begins between years 1 and 2. This is called Conventional
Gradient.

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Arithmetic Gradient Factors (P/G and A/G) Arithmetic Gradient Factors (P/G and A/G)

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Problem
1. Suppose that the maintenance expense on a certain machine is P10T at
the end of the first year and increasing at a constant rate of P500 each
year for the next four years. Determine the present worth of the total
maintenance expense if interest rate is 10%.

2. A loan was to be amortized by a group of four end-of-year payments

forming an ascending arithmetic progression. The initial payment was
to be P5T and the difference between successive payments was to be
P400, but the loan was renegotiated to provide for the payment of
equal rather than uniformly varying sums. If the interest rate of the loan
was 15%, what was the annual payment?

3. Find the equivalent annual payment of the following obligations at 20%

interest.
End of Year Payment
1 P8000
2 P7000
3 P6000
4 P5000

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