INTEREST

LESSON 8.1

• SIMPLE INTEREST
• COMPOUND INTEREST

Instructor: Ms. DANA A. FLORENDO, CPA, MM

INTEREST
Interest is the return earned by or the amount paid to someone who
has forgone current consumption or alternative investment
opportunities and “rented” money in a creditor relationship.
Key Terms:
§ Principal - The amount of money borrowed or invested.
§ Term of loan - The length of time or number of time periods
during which the borrower can use the principal.
§ Rate of interest - The percentage on the principal that the
borrower pays the lender per time period as compensation for
forgoing other investment or consumption opportunities.
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SIMPLE INTEREST
 Simple interest is the interest paid (for borrowed money) or
earned (for invested money) on the principal only.
 The amount of simple interest is equal to the product of the
principal times the rate per time period times the number of
time periods.
Where:
Formula: I simple interest amount

I=P*r*t
P Principal amount at time 0, or the
present value
r interest rate per year
3
t number of periods/ time
1. What is the simple interest on P1,000 at 10% per annum for
six months?
Solution:
Given:

P = P1,000 I = (P)(r)(t)
r = 10% p.a.
= (P1,000) (10% )(0.5)
t = 0.5*
I = ? = P50
* t = 6/12 (months per year)

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2. If William bought a house and borrowed P350,000 at a 10%
annual interest rate, what would be his first month’s
interest payment?
Solution:
Given:

P = P350,000 I = (P)(r)(t)
r = 10% p.a.
t = 1/12
= (P 350,000)(10%)(1/12)
I = ? = P 2,916.67

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3. Mary receives P300 every three months from a bank
account that pays a 6 % annual interest rate. How much is
invested in the account?
Solution:
Given:

P = ? I = (P)(r)(t)
r = 6% p.a. P 300 = (P)(6%)(3/12) Formula can also be
t = 3/12* P300 simplified as:

I = P300 P = I
(0.06) (0.25) P =
r*t
* t =Interest of P300 is received
quarterly or every 3 months
P = P20,000
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 FUTURE VALUE OF SIMPLE INTEREST
 Future Value is the amount the person can expect to receive
at some point in the future.
 It denotes the principal and interest accumulated at the end
of the t years.
Where:
Formula (can use any of the following): I simple interest amount

FVt = P + (P * r * t) P Principal amount at time 0, or the

present value
r interest rate per year
or FVt = P + I t number of periods/ time
FV Future value after t years 7
4. Ray borrows P10,000 for 9 months at a rate of 8 % per
annum. How much will he have to repay at the end of the 9-
month period?
Solution:
Given:

P = P10,000 FVt = P+ [(P)(r)(t)]

r = 8% p.a. = P 10,000 + (P 10,000 * 8% * 9/12
t = 9/12 = P 10,000 + P 600
I = ? = P 10,600
FVt = ?

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5. May agrees to invest P20,000 in a venture that promises to
pay 10% simple interest each year for two years. How much
money will she have at the end of two years?
Solution:
Given:

P = P20,000 FVt = P+ [(P)(r)(t)]

r = 10% p.a. = P 20,000 + (P 20,000 * 10% * 2
t = 2 = P 20,000 + P 4,000
I = ? = P 24,000
FVt = ?

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COMPOUNDING INTEREST
 Compound interest is interest that is paid not only on the
principal but also on any interest earned but not withdrawn
during earlier periods.
Time table illustration:

Principal I1 = P * r I2 = (P+I1)* r I3 = (P+I1+I2)* r

Now Yr. 1 Yr. 2 Yr. 3

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Tom deposits P10,000 in a savings account paying 6% interest
compounded annually, the future (compound) value of his
account at the end of one year (FV1) is calculated as follows:
Given:
Solution: FV1 = P * (1+r)
P = P10,000
r = 6% p.a. = P 10,000 * (1+ 6%)
t = 1
= P 10,000 * (1.06)
I = ?
FVt = ? = P 10,600
If Tom leaves his deposits of P10,000 plus the accumulated
interest in the account for another year, its worth in the end of
second year is calculated as follows:
P10,000 P10,000 P10,600
- + 600

t (Year) 0 1 2 3

Note:
FV1 of P10,600 will now become the basis for
Solution: computation of additional interest and FV in year 2.
FV2 = FV1 * (1+r)
= P 10,600 * (1+ 6%)
= P 10,600 * (1.06)
= P 11,236
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If Tom leaves his deposits of P10,000 plus the accumulated
interest for the 3rd year:

P10,000 P10,000 P10,600 P11,236

- + 600 + 636

t (Year) 0 1 2 3

Note:
FV2 of P11,236 will now become the basis for
Solution: computation of additional interest and FV in year 3.
FV3 = FV1 * (1+r)
= P 11,236 * (1+ 6%)
= P 11,236 * (1.06)
= P 11,910.16
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 P10,000 P10,000 P10,600 P11,236
P11,910.16
- + 600 + 636 +674.16

0 1 2 3 t (Year)
FV1 = P (1+r) FV2 = P (1+r) (1+r) FV3 = P (1+r)(1+r)(1+r)

Note:
We can see, that (1+r) is multiplying by itself by the number of period (t) and the number of conversion
(m), it is compounded.

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 To simplify the formula of FV for compounding interest, we derive the formula of…

Formula:
�
��� = � 1 + i
Where:
FV Future value after total number of conversion period (n)
P Principal amount at time 0, or the present value
i interest rate per period; that is, interest rate per year (r)
divided by number of conversions per year (m)
r
r interest rate per year i = n = tm
n total number of conversions period; that is number of periods m
(t) multiply by the number of conversions per year (m)
t number of periods/ time
m number of conversions per year (e.g., annually =1; semi- 15

annually =2; quarterly = 4)

If Tom deposits P10,000 in a savings account paying 6% interest
compounded annually, how much is the future value and the
accumulated interest of his account at the end of 5 years? 10 years?
Solution:
By the end of 5 years: By the end of 10 years:
6%
i = n = 5*1 =5 n = 10*1 = 10
1
= 6%
FV5 = � 1 + i � FV10 = � 1 + i �
5 = P 10,000 * 1 + 6% 10
= P 10,000 * 1 + 6%
= P 13,382.26 = P 17,908.48

I5 = FV5 – P I10 = FV10 – P

= P 13,382.26 - P 10,000 = P 17,908.48 - P 10,000
= P 3,382.26 = P 7,908.48
FUTURE VALUE INTEREST FACTOR (FVIF)
 Future Value Interest Factor (FVIF) provides a listing of
future value interest factors for various interest rates(i)
covering up to 60 periods (years or other time periods).
�
�����, � = 1 + ⅈ
 Using the FVIF, we can compute for FV of compounded
interest over the period as:

��� = � �����, � )
If we are to look for 6% in 5 years compounded annually: 6% for 5 years

Note: Some FVIF table provide more than 3 decimal places for more accurate computation. 18
 SOLVING FOR INTEREST RATE OF COMPOUNDED PROBLEM

An investment requiring an initial outlay of P10,000 promised a

return of P16,290 after 10 years, what is the interest rate of the
investment? Solution using the FVIF table :
Given: FVn
Conversion of formula: FVIFi,10 =
P = P10,000 P
n
���   =  P  1 + i
FV10 = P16,290 P16,290
FVn =
n = 10 1+i n
= P10,000
P
i = ? Note: = 1.629
�
�����, � = 1 + ⅈ
Once the FVIF factor is computed, look into the
table with period of 10 and locate the rate with
the nearest value with the FVIF.
FVIF of 1.629 for period of 10 is under 5% rate. Thus, the interest rate (i) is 5%
as the principal is compounded annually. 20
 SOLVING FOR INTEREST RATE OF COMPOUNDED PROBLEM

An investment requiring an initial outlay of P10,000 promised a

return of P16,290 after 10 years, what is the interest rate of the
investment?
Solution using scientific calculator:

n
FVn
1+�   =
P
1 + ⅈ 10   = 1.629
1 + ⅈ  = 10 1.629  
ⅈ  = 1.05 – 1
ⅈ  = 5%
 SOLVING FOR NUMBER OF COMPOUNDING PERIOD
Determine how long it takes for P10,000 invested at 8%
annually to double? Solution:
Given: FVn
n
P = P10,000 ���   =  P  1 + i n 1+�   =
P
FVn = P20,000 P20,000
FVn 1 + 8% n
=
n = ? 1+i n
= P10,000
P
i = 8% 1.08 n
= 2

Note: Number of period can be solved either by the

use of FVIF table or scientific calculator.
Solution by the use of FVIF table:
Look into the table with rate of 8% and locate the period with the nearest FVIF equivalent value of 2.

It will take 9 years to double the P10,000 if invested at 8% annually. 23

Solution by the use of scientific calculator:

n
FVn
1+�   = n log (1.08) = log 2
P
log 2
P20,000 n =
1 + 8% n
= log (1.08)
P10,000
n
n = 9
1.08 = 2

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