MATH IF (MATHEMATICS OF THE MODERN WORLD)

MODULE 1
Compound Interest

Section 1
Relation of
Compound
Interest to
Simple Interest

Section 2
Present Value
and Future Value

Section 3
Manipulating Compound Amount Formula
and Equivalent Values

COLLEGE OF BUSINESS AND ACCOUNTANCY

RATIONALE

The goal of the course is for students to develop the computational skills they
will need to be successful in the world of business along with a better understanding
of business concepts and situations that require a mathematical solution.
Specifically, the students are expected to understand the concepts on simple
interest, simple discount and able to apply this concept in various business
transactions in which calculation are required

INSTRUCTIONS TO USERS

Read the main content of the module under developmental activities sections and
answer the problems indicated in the closure activities.

The learners should have a good background on the following concepts

1. Whole numbers, decimals, fractions, and percent

2. Rules in manipulating equations and formulas.
3. Fluency in calculator use is required.

MODULE 1 LEARNING OBJECTIVES

1. Calculate simple interest and bank discount.

2. Manipulate simple interest and bank discount formula.
3. Apply simple interest and bank discount concepts in discounting promissory
notes.
Section 1
Relation of Compound Interest to Simple Interest

Section Objectives:
1. Use the simple interest formula I = PRT to calculate compound interest.
2. Identify interest rate per compounding period and number of compounding periods.
3. Use the formula M = P(1 + i) n to find compound amount.
4. Use the table to find compound amount.

Present value is the value of an investment today, right now. Money left in an
investment usually grows over time. The amount in an investment at a specific future date is
called the future amount, compound amount, or future value. The future value depends
not only on the amount initially invested, it also depends on the following:
1. Compound interest—Compound interest results in a greater future value than simple
interest.
2. Interest rate—A higher rate results in a greater future value.
3. Length of investment—An investment held longer usually results in a greater future
value.
To see the effects of these, compare the future values of a P 10,000 investment using the
following table:
 Investments A and B show the value of compound interest over simple interest.
 Investments B and C show the value of a higher interest rate.
 Investments C and D show the value of a longer investment period.

Investment Term Annual Rate Interest Future Value

A. Simple interest 6 years 5% P 3,000 P 13,000
B. Compound interest 6 years 5% P 3,401 P 13,401
C. Compound interest 6 years 8% P 5,869 P 15,869
D. Compound interest 10 years 8% P 11,589 P 21,589

The graph shows the power of compound interest over time using an investment of P 10,000
earning 5% and 8% per year compared to the same amount accumulated via simple interest.
 Comparison of Simple interest and Compound
Interest
80000

70000

60000

50000

40000

30000

20000

10000

0
0 5 10 15 20 25 30

Simple Interest 5% Compound Interest at 5%

Compound Interest at 8%

OBJECTIVE 1 Use the simple interest formula I =PRT to calculate compound interest.
Compound interest is interest calculated on previously credited interest in addition
to the original principal. Compound interest calculations often require that interest be
calculated and credited to an account more than once each year.

Example 1
Regina Foster wants to compare simple interest to compound interest on a P 200,000
investment.
(a) Find the interest if funds earn 6%, simple interest for 1 year.
(b) Find the interest if funds earn 6% interest compounded every 6 months for 1 year.
(c) Find the difference between the two.
(d) Find the effective rate for both.

Solution
(a) Simple interest on P 200,000 at 6% for 1 year is found as follows.
I = PRT = P 200,000 * .06 * 1 = P 12,000
(b) Interest compounded every 6 months means that interest must be calculated at the
end of each 6-months using I = PRT. Add interest to principal before proceeding.

Interest for first 6 months: PRT = P 200,000 * .06 * 6/12 = P 6000

Principal at end of first 6 months = Original principal + Interest

= P 200,000 + P 6000 = P 206 000
The new principal of P 2060 earns interest for the second 6 months.
Interest for second 6 months = PRT = P 206000 * .06 * 6/12
= P 6180
Principal at end of 1 year = P 206000 + P 6180 = P 212180

The interest earned in the second 6 months (P 6180) is larger than that earned in the
first 6 months (P 60), since the first interest amount of P 60 is also earning interest
during the second 6 months.

Total compound interest = P 6000 + P 6180 = P 12180

(c) Difference in interest = P 12180 - P 12000= P 180

Compound interest results in more interest. The difference here of P 180 seems trivial,
but compound interest results in huge differences over time.

(d) The effective interest rate is the interest for the year divided by the original
investment.

Effective Interest Rate

Funds earning 6% simple interest P 12000÷P 200000 = 0.06=6%
Funds earning 6% compounded every 6 months P 12180÷P 200000 =0.061= 6.1,
(rounded)

Although they have the same nominal rate (6%), the compound interest investment
has a larger effective interest rate due to compounding.
 Finding Future Value (Compound Amount)
1. Use I = PRT to find simple interest for the period.
2. Add principal at the end of the previous period to the interest for the current period to
find the principal at the end of the current period.

Quick Check 1
P 15,000 is invested for 1 year. Find the future value based on (a) simple interest of 8, and
(b) 8, interest compounded every 6 months. (c) Then find the difference between the two.
Example 2
The Simons need P 5000 in 4 years for a down payment on a new car. They invest P
3800 in an investment that pays 6% interest compounded annually. (a) Find the excess of
compound interest over simple interest at the end of 5 years. (b) Will they have enough
money to meet their goal?

Solution
First calculate interest using I = PRT and round to the nearest cent. Then find the new
principal by adding the interest earned to the preceding principal

Compound
Yea Interes
r P x R x T t P + I Amount
380,0 380,0 22,8
1 00 x 0.06 x 1 = 22,800 00 + 00 = 402,800
402,8 402,8 24,1
2 00 x 0.06 x 1 = 24,168 00 + 68 = 426,968
426,9 426,9 25,6
3 68 x 0.06 x 1 = 25,618 68 + 18 = 452,586
452,5 452,5 27,1
4 86 x 0.06 x 1 = 27,155 86 + 55 = 479,741
479,7 479,7 28,7
5 41 x 0.06 x 1 = 28,784 41 + 84 = 508,526
508,52 380,0 128,52
Compound Interest = 6 - 00 = 6
PRT 114,000.0
Simple Interest = = 380,000*0.06*5 = 0
128,52 114,000. 14,525.7
Difference = 6 - 00 = 2

Quick Check 2
Find the future amount at the end of 2 years for an P 80,000 investment that earns 7% per
year

OBJECTIVE 2 Identify interest rate per compounding period and number of

compounding periods.
The compounding period is the time over which interest is calculated and added to
principal. It can be annually (once a year), semiannually (two times a year), quarterly (four
times
a year), monthly (12 times a year), etc. The number of compounding periods is the number of
the compounding periods per year, or in the life of the loan when talking about a loan.

Interest Compounded at Number of Compounding

Compounded the End Every Periods in 1 Year
Annually Year 1
Semi-annually 6 months 2
Quarterly 3 months 4
Monthly 1 months 12
Daily 1 day 365

The interest rate per compounding period is the interest rate applied to each
compounding period. It is found by dividing the annual interest rate by the number of
compounding periods in a year. The total number of compounding periods is the number per
year times the number of years as shown. So, a loan compounded semiannually for 4 years
will be compounded every 6 months for 4 years, or 8 times.

Number of
    Compounding Term Rate per Total Number of
Rate Periods per Year Compounding Compounding Period
(j) Compounded m  t Period (i=j/m) (n=m*t)
8% Semi- 2 4 years 8%/2=4% 4 years x 2 = 8
 annually
12% Monthly 12 2 ½ years 12%/12=1% 2 ½ x12=30
4% Quarterly 4 5 years 4%/4=1% 5 years x 4 =20

Quick Check 3
Find the interest rate per compounding period and the number of compounding periods for
each.
(a) 5% compounded semiannually, 3 years
(b) 6% per year, compounded monthly, 2 ½ years
(c) 2% per year, compounded quarterly, 5 years

OBJECTIVE 3 Use the Compound Amount formula to find compound amount.

Formulas for Compounding Interest

Maturity value/Future Value: F =P(1 +i)n
Interest: I=F-P
where
P = initial investment
n = total number of compounding periods
i = interest rate per compounding period
Example 3:
An investment managed by Bank of America pays 7% interest per year compounded
semiannually. Given an initial deposit of P 4500, (a) use the formula to find the compound
amount after 5 years, and (b) find the compound interest.

Solution
Interest is compounded at 7% /2 = 3.5% every 6 months for 5 years * 2 periods per year =10
periods. Therefore, 3.5% is the interest rate per compounding period (i) and 10 is the
number of compounding periods (n).

M = P(1 + i)n
= P 4500 * (1 + .035)10
= P 4500 * (1.035)10
= P 6347.69 (rounded)
The compound amount is P 6347.69.

I=M-P
= P 6347.69 - P 4500 = P 1847.69
The interest is P 1847.69

Quick Check 4
Use the formula for maturity value to find the compound amount and interest on a P 9000
investment at 2% compounded semiannually for 5 years.
OBJECTIVE 4 Use the table to find compound amount.
The value of (1 + i)n in the formula M = P(1 + i)n can be calculated using a calculator,
or it can be found in the compound interest table below. The interest rate i at the top of the
table is the interest rate per compounding period. The value of n down the far left (or far
right) column of the table is the total number of compounding periods. The value in the body
of the table is the compound amount, or maturity value, for each P 1 in principal.

Compound Amount Table Factors

 Finding Compound Amount (Future Value)
Compound amount = Principal * Table Factor

Example 5:
In each case, find the interest earned on a P 2000 deposit.
(a) For 3 years, compounded annually at 4%
(b) For 5 years, compounded semiannually at 6%
(c) For 6 years, compounded quarterly at 8%
(d) For 2 years, compounded monthly at 12%

Solution
(a) In 3 years, there are 3 * 1 = 3 compounding periods. The interest rate per compounding
period is 4% / 1 = 4%
Look across the top of the compound interest table above for 4% and down the
side for 3 periods to find 1.12486.

Compound amount = M = P 2000 * 1.12486 = P 2249.72

Interest earned = I = P 2249.72 - P 2000 = P 249.72

(b) In 5 years, there are 5 * 2 = 10 semiannual compounding periods. The interest rate per
compounding period is 6%/ 2 = 3%. In the compound interest table, look at 3% at the
top and 10 periods down the side to find 1.34392.

Compound amount = M = P 2000 * 1.34392 = P 2687.84

Interest earned = I = P 2687.84 - P 2000 = P 687.84

(c) Interest compounded quarterly is compounded 4 times a year. In 6 years, there are
6 * 4 = 24 quarters, or 24 periods. Interest of 8% per year is 8%/4 = 2% per quarter. In
the compound interest table, locate 2, across the top and 24 periods at the left, finding the
number 1.60844.

Compound amount = M = P 2000 * 1.60844 = P 3216.88

Interest earned = I = P 3216.88 - P 2000 = P 1216.88

(d) In 2 years, there are 2 * 12 = 24 monthly periods. Interest of 12% per year is 12/12 = 1%
per month. Look in the compound interest table for 1% and 24 periods, finding the number
1.26973.

Compound amount = M = P 2000 * 1.26973 = P 2539.46

Interest earned = I = P 2539.46 - P 2000 = P 539.46
Quick Check 5
Find the interest earned on a P 5000 deposit for 4 years at 6, compounded semiannually.

Section 1 Exercises. Provide a Concise solution as indicated in the example.

Use the formula for compound amount, not the table, to find the compound amount and
interest. Round to the nearest cent
Compound Amount Interest
1. P 12,000 at 8% compounded annually for 4 years P 16,325.87 P 4325.87
Compound interest is 8% per year for 4 years.
F = P 12,000 * (1 + .08) 4= P 16,325.87
I = P 16,325.87 - P 12,000 = P 4325.87
2. P 14,800 at 6% compounded semiannually for 4 years ________ _________

3. P 28,000 at 10% compounded quarterly for 1 year ________ ________

4. P 20,000 at 5% compounded quarterly for ¾ year _________ ________

Use values from the compound interest table to find both the compound amount and the
compound interest. Round the compound amount to the nearest cent.

Compound Amount Interest

1. P 32,350 at 6% compounded annually for 4 years __________ __________

2. P 18,000 at 1% compounded annually for 10 years __________ __________

3. P 12,300 at 3% compounded semiannually for 4 years__________ __________

4. P 12,500 at 8% compounded quarterly for 5 years __________ __________

Find the simple interest for the period indicated. Then use table values to find the
compound interest. Finally, find the difference between compound interest and simple
interest. Round each to the nearest cent. (Interest is compounded annually.)

Number Simple Compound

Principal Rate of Years Interest Interest Difference

1. P 5400 6% 4 _________ __________ _____________

2. P 9200 5% 6 _________ __________ _____________

3. P 1200 8% 15 _________ __________ _____________

4. P 4625 4% 10 _________ __________ _____________

Solve the following application problems. Round to the nearest cent. Use any method.

1. Vickie Ewing deposits her savings of P 2800 in an investment paying 6%

compounded quarterly and she leaves it there for 5 years. Find (a) the compound
amount and (b) the interest.
 2. John Crandall deposited P 6000 in an account at a bank that pays 5% compounded
semiannually for 4 years. Find (a) the compound amount and (b) the interest.

3. A firm in the UK places £42,000 (forty-two thousand pounds) in a bond paying 6,

compounded quarterly and leaves it there as collateral for a loan. Find (a) the balance
in the account after 1 year and (b) the interest.

4. A firm in the UK places £42,000 (forty-two thousand pounds) in a bond paying 6,

compounded quarterly and leaves it there as collateral for a loan. Find (a) the balance
in the account after 1 year and (b) the interest.

5. Jan Reus sold her home and has P 18,000 to invest. She believes she can earn 8,
compounded quarterly. Find the compound amount if she invests for (a) 3 years and
(b) 6 years. (c) Then find the additional amount earned due to the longer time period.

Section 2 Present Value and Future Value

Section Objectives:
1. Define the terms future value and present value.
2. Use table and formula to calculate present value.
OBJECTIVE 1 Define the terms future value and present value.

Future value is the amount available at a specific date in the future. It is the amount
available after an investment has earned interest. All of the values found in Sections 1 were
future values.
In contrast, present value is the amount needed today so that the desired future value
will
be available when needed. For example, an individual may need to know the present value
that
must be invested today in order to have a down payment for a new car in 3 years. Or a firm
may need to know the present value that must be invested today in order to have enough
money to purchase a new computer system in 20 months. The bar chart shows present value
as the value today and future value as the value at a future date.

OBJECTIVE 2 Use tables to calculate present value.

First, find the interest rate per compounding
period (i) and the total number of compounding periods (n) of the investment. Then
use these values to find the appropriate value in the Present Value Table Factor. Finally,
use the formula to find present value.

Finding Present Value

Present value P = Future value * Table Factor

Table Factors for Present Value

Example 1:
 Betty Clark needs to replace two pumps at her gas station in 3 years at an estimated
cost of P 12,000. What lump sum deposited today at 5% compounded annually must she
invest to have the needed funds? How much interest will she earn?

Solution
Step 1: The interest rate is 5, per compounding period for 3 compounding periods
(years in this case). Look across the top of the table for 5% and down the left
column for 3 to find 0.86384.
Present value = P 12,000 * .86384 = P 10,366.08
Step 2 Interest earned = P 12,000 - P 10,366.08 = P 1633.92.
Step 3 Check the answer by finding the future value of an investment of P 10,366.08
in an account earning 5% compounded annually for 3 years. Use the table
above to find 1.15763.
Future value = P 10,366.08 * 1.15763 = P 12,000.09
The reason it is not exactly P 12,000 is rounding in the table value

Example 2
The local Harley-Davidson shop has seen business grow rapidly. The owners plan to
increase the size of their 6000-square-foot shop in one year at a cost of P 280,000.
How much should be invested in an investment earning 6, compounded
semiannually to have the funds needed?

Solution
The interest rate per compounding period is 6%/2 = 3%, and the number of
compounding
Periods is 1 year * 2 periods per year = 2. Use the table to find .94260.
Present value = P 280,000 * .94260 = P 263,928
The difference between the P 280,001.22 and the desired P 280,000 is due to
rounding.

Quick Check 1
In 5 years, Great Lakes Dairy estimates it will need P 350,000 for a down payment to
purchase a nearby farm. Find the amount that should be invested today to meet the down
payment if funds earn 8% compounded quarterly.

Example 3
Radiux Inc. wishes to partner with a Korean company to purchase a satellite in 3
years. Radiux plans to make a cash down payment of 40, of its anticipated P 8,000,000 cost
and borrow the remaining funds from a bank. Find the amount Radiux should invest today in
an investment earning 6% compounded annually to have the down payment needed in 3
years.

Solution
First find the down payment to be paid in 3 years.
Down payment = .40 * P 8,000,000 = P 3,200,000
This is the future value needed exactly 3 years from now. Using the present value of a dollar
table on page 420 with 3 periods and 6% per period gives
P= P 3,200,000 * .83962 = P 2,686,784
Radiux must invest P 2,686,784 today at 6% interest compounded annually to have the
required down payment of P 3,200,000 in 3 years.

Quick Check 2
Mom and Pop Jenkins plan to buy a new car in 2 years and want to make a down payment
of 25% of the estimated purchase price of P 32,000. Find the amount they need to invest to
make the down payment if funds earn 6% compounded quarterly.

Objective 2 Compute Present Value using present Value formula

Formula for Present Value

F
Present Value : P= n
=F(1+i)−n
(1+i )
Solve a) Example 1 and 2 using the present value formula
a) The interest rate is 5% (i) per compounding period for 3 compounding periods (n)
F
P=
( 1+i )−n
12000
P=
( 1+0.05 )3
12000
P=
1.157625
¿ 10,366.08(rounded)
b) The interest rate per compounding period is 6%/2 = 3%, and the number of
compounding periods is 1 year * 2 periods per year = 2.

−n
P=F ( 1+i )
P=280,000 ( 1+0.03 )−2
280,000∗0.94260(rounded)
¿ 263,928(rounded)

Quick Check 3
Solve quick check number 2 using present value formula.

Objective 3. Find Present and Future Value for n periods when n is not a whole
number.
When deriving the compound interest formula, the time is assumed to be an integer.
However, when n is not a whole number and there is a fractional part of the period, the usual
practice is to allow simple interest for this fractional part in computing the final amount. This
method will be illustrated in the following examples.

Example 4:
 Find the compound amount at the end of 3 years and 5 month if P 20,000 is invested
at 8% compounded semi-annually.

Solution:
The interest rate per period is 8%÷2=4% compounded semi-annually and P=20,0000
The total time in this case is 6 whole periods ( 3 years*2=6) and 5 months left over or
fraction of a period. The compound amount at the end of 6 whole periods is:
F = P 20000(1+0.04)6
= P 25, 306.38
The interest for the remaining 5 months, using I=PRT
I= (P 25,306.38)(0.08)(5/12)
= 843.55
Therefore, the final amount at the end of 3 years and 5 months is:
F= P 25,306.38 + 843.55
= P 26,149.93 (rounded)
Alternatively, this can be computed as
F=P(1+i)n(1+ RT)
F= ( 25,000)(1+0.04)6 (1 + 0.08*5/12) = P 26, 149.93

Quick Check 4
Find the compound amount of P 95,500 for 2 years and 10 months at 16% compounded
quarterly.

Example 5
Find the amount to be invested today in order to accumulate P 300,000 after 5 years
and 4 months if the money will grow at 10% compounded quarterly.

Solution:
Given a final amount of F=300,000 , i=10%÷4=2.5% and there are 21 quarters and 1
excess month within 5 years and 4 months. We are going to add 2 more months to make the
fractional part be equivalent to 1 quarter making n=22. Compute the present value using n=22
 P= F(1+i)-n
= P 300,000(1+0.025)-22
=P174, 259.40
Note that this value is lower than the true present value because of the additional 2 months. In
order to compensate for the true value of P, we are going to compute the simple interest of
the initial value of P.
I = PRT
= (P 174, 259.40)(0.10)(2/12)
= P 2904.32 (rounded)
The true present value is
P = P 174, 259.40 + P 2904.32
= P 177, 163.72 (rounded)

Quick Check 6
If P 275,000 is due in 4 years and 11 months, what is its equivalent present value if interest is
12% compounded semiannually?

Objective 4 Nominal Rate and Effective rates.

The effective rate of interest is the equivalent annual rate of interest which is
compounded annually. Further, the compounding must happen more than once every year.
Let’s look at an example for better clarity:
Peter invests P 10,000 for one year at the rate of 6% per annum. The interest is
compounded semi-annually. Calculate the interest earned in the first six months (I1).
I1 = P 10,000 x 0.06 x 6/12 = P 300.
Since the interest is compounded, the principal for the next 6 months = 10,000 + 300 = P
10,300. Therefore, the interest earned in the next six months (I2) is,
I2 = 10,300 x 0.06 x 6/12 = P 309.
Hence, the total interest earned during the year I = I1 + I2 = 300 + 309 = P 609. We
know the formula for interest is I = PRT … where ‘I’ is the interest, ‘P’ is the principal
amount, ‘T’ is the time period, and ‘R’ is the rate of interest. In the case of this example, R =
E or the effective rate of interest. Therefore, we have,
I P 609
E= = =0.069=6.9 %
PT P 10,000∗1

Effective rates can also be derived using compound amount formula.

Interest earned ∈one year

E=
Principal at the beginning of the year
F−P
E=
P
P(1+i)n−P
E=
P
E ¿(1+i )n−1
j m
E ¿(1+ ) −1
m

Solving the previous example using this formula, where j=6%, m=2 (semi-annually)
0.1 2
(
E ¿ 1+
2 ) −1
E=1.069−1=0.069=6.09 %

Quick Check 7
Find the effective rate of an investment of P 100,000 if the money is yields 8%
compounded quarterly for one year.
.

Section 2 Exercises
Find the present value of the following using table factors. Verify your answer using the present value
formula. Round to the nearest cent. Also, find the amount of interest earned.

Amount Needed Time (Years) Interest Compounded Present Value Interest Earned

1. P 12,300 3 6% annually ___________ ____________

2. P 14,500 2½ 8% quarterly ___________ ____________

3. P 9350 4 5% semiannually ___________ ____________

4. P 850 10 9% semiannually ___________ ____________

5. P 18,853 11 6% quarterly ___________ ____________

Solve the following application problems. Round to the nearest hundredths.

1. A P 50,000 loan was secured on August 15, 2010 at an interest rate of 16% compounded
semi-annually. What will be the accumulated amount if it is due on March 15, 2011?
 2. A man borrowed P 200,000 at an interest rate of 25%, compounded quarterly. If he intends to
pay the accumulated amount in 5 years and 7 months, how much will he pay?

3. Determine the nominal interest rate compounded quarterly if the effective interest rate is 9%
per annum (correct to two decimal places).

4. Cebela is quoted a nominal interest rate of 9.15% per annum compounded every four months
on her investment of P 85 000. Calculate the effective rate per annum.

5. Miranda invests P 80, 000 for for her son's study fund. Determine how much money she will
have at the end of the year and the effective annual interest rate if the nominal interest of 6%
is compounded quarterly.

6. An investment company advertised that they are paying 12% compounded monthly. If an
investor transfers P 100,000 to this investment company from another investment company
that pays 12%compounded quarterly, how much additional interest a year will he get, if there
is any?

Section 3Manipulating Compound Amount Formula

Finding the Interest rate. In the Basic formula F= P(1+i)n , the interest rate can be
derived and it is given by
 Formula for Interest Rate per compounding period
n F
i=
P
−1
√
Where
F= Final Amount
P = initial investment
n = total number of compounding periods
i = interest rate per compounding period

Example 6
If P 50,000 amounts to P 70,000 in 5 years with interest compounded semi annually,
what is the nominal rate of interest?
Solution
In the problem, P= P 50,000; F= P 70,000 and n=5years*2=10, the interest per period
is then given by
F
i=
√
n

P
−1

P 70,000
i=
√
10

P 50,000
−1

i=1.0342−1
i=0.0342=3.42% semiannually
The nominal rate is i=j/m, therefore j=i*m
j=3.42∗2=6.84 % (rounded)

Quick Check 8
If P 40,000 accumulates to P 100,000 in 10 years, find the nominal rate if the interest is
computed quarterly?
 Finding the time. In the compound amount formula, time is associated with n, the
number of compounding period. Since n=m*t, then, t= n/m. The formula for n is given by:

Formula for n
F
log( )
P
n=
log(1+i)

Where
F= Final Amount
P = initial investment
i = interest rate per compounding periods

Example 7
How long will it take P 20,000 to amount to P35,000 at 10% compounded quarterly?
Solution
Given P=P20,000, F=P35,000 and i=10%÷4=2.5%
F
log( )
P
n=
log (1+i)

FP 35,000
log ( )
P 20,000
n=
log (1+0.025)
n=¿22.66 quarters

Therefore, time is t=n/m=22.66/4=5.67 years.

Quick Check 9
How long will a principal of P 60,000 reach to an amount of P85,000 if it earns 6%
compounded semiannually?
Equivalent Values

A single obligation or a set of obligations may be replaced by a single obligation or a set of

obligations due on dates rather than the original obligations’ due date. For the mutual benefit
of the creditor and the debtor, the new obligations should be equivalent values of the original
ones. An equation of values makes the original obligations and the new obligations to be
equal of equal value on a comparison date. Examples of such situations are as follows:
1. If a money is borrowed at 6% compounded annually for 3 years P 10,000 now and
shall repay P 11,910 after 3 years.
2. On the other hand, at the same rate and the same period, accreditor may agree that his
debtor pay P 8396 now for a debt of P10,000 that is due in 3 years.
The values in the two transactions are equivalent to each other under the compound interest
method.
Example:
Caedmon owes P30,000 due in 3 years and P40,000 due in 8 years. He and his creditor have
agreed to settle the debts by two equal payments in five and six years, respectively. Find the
size of each payment if money is worth 6% compounded semiannually. Let the debt of
P30,000 as debt (a) and the debt P 40000 as debt (b).
Let x be each payment and the comparison date be six years from now. The values on the
comparison date ae computed as follows:
1. The value of the old debt (a) P30,000 becomes P 35,821.56 on the comparison date.
Consider PV= P30,000, i=3% (6%/2), n=6 (3 years due date to comparison date x 2
compounding periods per year). The compound amount is’
FV= P30,000 (1+.03)6
= P 35,821.56
2. The value of the old debt (b) of P 40,000 becomes P 35,539.8 on the comparison
date. Consider FV= P40,000, i=3% and n=4 ( 2 years from the comparison date to the
due datex2 compounding period per year). The present value is,
PV= P30,000 (1+.03)-4
=P 35,539.8
3. He value of the new debt, which is the first payment due in 5 years becomes 1.0609x
on the comparison date. Consider PV=x, i=3%, n=2 (1 year from the 5 th year, the date
on which the 1st equal payment is made to the 6th year which is the comparison date
time 2 compounding periods per year.
 FV= x (1+.03)2
=1.0609x

4. The value of the second payment due in 6 years is x. It does not change since the
comparison date is also 6 years. The equation of value based on the comparison date
is given below:
New debts = Old Debts
x + 1.0609x = P35821.56 + 35539.48
2.0609x = 71,361.04
x= P34, 626.15
Hence Caedmon should pay P34,626.15 on the 5th year and another P34626.15 at the
end of the 6th year.

Example 2:
Psalm owes P70,000 due in 3 years and P100,000 due in 8 years. His creditor has
agreed for him to pay the debts with a payment of P80,000 and the remainder in 5 years. If
money is worth 4% compounded annually, what size must the second payment be. Let the
debt of P70,000 as debt (a) and the debt (b) for the debt of P100,000.

Let x be the second payment, which is to be made on the comparison date,or five years hence.
The values on the comparison date are computed as follows:

1. The value of the old debt (a) of P70,000 becomes P 75,712 on the comparison date.
Consider PV=70,000, i=4%, n=2 ( ( 2 years from the comparison date to the due date
x 1 compounding period per year)

FV = 70,000 (1+.04)2

= P 75, 712

2. The value of the old debt (b) of 100,000 becomes P88,899.60 on the comparison date.
Consider FV= P100,000, i=4%, n= 3 ( 3 years from the comparison date to the due
date x 1 compounding period per year)

PV= 100,000(1+.04)-4

= P88,899.60
 3. The value of the new debt, which is the first payment of P80,000 after 1 year becomes
P93,588.72 on the comparison date. Consider PV=80,000, i=4%, n= 4 ( 4 years form
the comparison date to the due date x 1 compounding period per year)

FV= 80,000(1+.04)4

= P93,588.72

4. The value of the second payment due in 5 years is x. It does not change since the
comparison date is also five years. The equation of value based on the comparison
date follows:
New debts = Old Debts
x = 75,712+88,899.60
x = 75,712+88,899.60 - 93,588.72
x = P 71,022.88
Hence, Psalm should pay P 80,000 at the end of the 1 st year and another P 71,022.88
at the end of the 6th year.

Section 3 Exercises
Solve the following application problems. Round to the nearest hundredths.

1. If you deposit $8000 into an account paying 7% annual interest compounded

quarterly, how long until there is $12400 in the account?
 2. At 3% annual interest compounded monthly, how long will it take to double your
money?

3. If you deposit $5000 into an account paying 6% annual interest compounded monthly,
how long until there is $8000 in the account?

4. A man invested P 150,000 on his first child’s birth. If he wishes to double the amount
he invested after 7 years, at what rate compounded quarterly should she invest?

5. If P100,000 pesos earned an interest of P12500 in 3 years, at what nominal rate was it
invested compounded semiannually?

6. How long will it take any investment to double its amount if invested to an account
paying 8% compounded quarterly?

Solve the following application problems. Round to the nearest hundredths.

1. Ezekiel owes P50,000 due in two years and P100,000 with interest 16% compounded
quarterly due in 3 years. If money is worth 18% compounded semiannually, what single
payment seven years hence will be equivalent to the two original obligations.
2. Instead of taking P 300,000 each from an insurance policy, a beneficiary chooses to take
three annual payments, the first is to be made now. If the insurance company pays 8%
effective on money left with them, what is the size of the payments?

3. Mr. Ang owes Mr Tan P50,000 due at the end of 3 years and P80,000 due at the end of 7
years. Mr Ang is allowed to replace these obligations be a single payment at the end of 5
years. How much should he pay if the money is worth 14% compounded semi annually?

4. A man owes P 75,000 due now. The lender agrees to let hi pay his obligation with two
equal payments due after 1 and 2 years respectively. If the money is worth 12%
compounded semi-annually, what would the size of each payment.
SYNTHESIS

Formulas under compound interest topics

Compound amount = Principal * Table Factor

F =P(1 +i)n

Present value P = Future value * Table Factor

 F
P= n
=F(1+i)−n
(1+i )

Effective rates
Interest earned ∈one year
E=
Principal at the beginning of the year

Formula for Interest Rate per compounding period

n F
i=
P√−1

Formula for time (n)

F
log( )
P
n=
log(1+i)

References

Ballada, Ballada, Math in the Business World, 2019, 1st edition

Ballada, Ballada, Investment Mathematics, 2012 issue

Mathematics in the Modern World
Mathematics of Investment 5th Edition by Asuncion C. Mercado Del Rosario, copyright
2011, Del Ros Publishing House

Clendenen G., Salzman S. Business Mathematics 13ed 2015, Pearson Publishing,