Cairo University

Faculty of Engineering
Chemical Engineering Department
Fourth Year

Economics

Interest

Eng. Nourhan Hisham

INTEREST
 Interest
• Interest ≡ Time value of money.

• Interest is the fee charged by a lender to a borrower for

the use of borrowed money

• It is usually expressed as an annual percentage of

the principal.

• Interest per year divided by principal amount,

expressed as a percentage also called interest rate.
 Important Definitions

• P Principal, the starting amount of money

• S Future value, sum, resultant, final money
• n Number of years (or period)
• i Interest rate (it may be annual , every 6 months ,every 3 months,
monthly)
• m Number of interest periods per year
• r Nominal interest rate
• i eff Effective interest rate
Interest Types
Simple vs. Compound vs. continuous

1- Simple interest:

Interest = P*n*i

S = P + P*n*i

S = P(1+i*n)
Interest Types
2- Discrete compounding interest:

𝑆 = 𝑃(1 + 𝑖)𝑛
i: annual interest rate
- Also if you have nominal interest rate use the law:
𝑟 𝑛.𝑚
𝑆 = 𝑃(1 + )
𝑚
𝑟
𝑆 = 𝑃(1 + )𝑛.𝑚 = 𝑃(1 + 𝑖𝑒𝑓𝑓 )𝑛
𝑚

𝑟
For n=1, (1 + )𝑚 = 1 + 𝑖𝑒𝑓𝑓
𝑚
𝑟 𝑚
𝑖𝑒𝑓𝑓 = (1 + ) −1
𝑚
Interest Types

3- Continuous compounded interest:

𝑆 = 𝑃𝑒 𝑟.𝑛
𝑖𝑒𝑓𝑓 = 𝑒 𝑟 − 1

Where:
r: Nominal annual interest rate
n: # of years
Interest Types
25000

20000

15000
Future Worth, $

S, Simple
S, Discrete
10000 S, Continuous

5000

0
0 2 4 6 8 10 12
Time, years
Interest Types

• Notes:
1- Simple interest is favorable when you borrow money.
2- The continuous compounded is favorable in case of putting
money in a bank.
3- Most of banks works by discrete interest type (As it has
intermediate value).
4- In most of our problems we use discrete.
5- If the interest type is not given, use simple interest.
LET’S BEGIN OUR SHEET
1) An individual borrows $1000 at 12% compounded
annually. If the loan is paid pack after 5 years, how
much is repaid?

P = $1,000
i = 0.12
Compound interest
n =5
S =?

𝑆 = 𝑃(1 + 𝑖)𝑛
𝑆 = 1000(1 + 0.12)5
𝑺 = $𝟏, 𝟕𝟔𝟐. 𝟑𝟒
2) Person A borrows $4,000 from person B and agrees to
pay $1000 plus accrued interest at the end of the first year
and $3,000 plus the accrued interest at the end of the
fourth year. What are the amounts of the two payments if
8% annual interest applies?

Year Zero Year One Year Four

P = $4,000 n=1 n=4
i = 0.08 S1= $1,000 + Interest 1 S1= $3,000 + Interest 2
Simple interest
S1 = ? Interest 1 = i * P * n Interest 1 = i * P * n
S2 = ? = 0.08 * 4000 * 1 = 0.08 * 3000 * 3
= $ 320 = $ 720

S1 = $ 1,320 S2 = $ 3,720
3) Person A wishes to accumulate $1,000 in a saving
account 4 years from now and the account pays
interest at a rate of 9% compounded annually. How
much must be deposited today?
S = $1,000
n =4
i = 0.09
Compound interest
P =?

𝑆 = 𝑃(1 + 𝑖)𝑛
1000 = 𝑃 ∗ (1 + 0.09)4
𝑷 = $𝟕𝟎𝟖. 𝟒𝟑
4) It is desired to have $9,000 available 12 years from
now. If $5,000 is available for investment at the present
time. What discrete annual rate of compound interest on
the investment would be necessary to give the desired
amount?
S = $9,000
n = 12
P = $5,000
i =?
Compound interest
𝑆 = 𝑃(1 + 𝑖)𝑛
9000 = 5000 ∗ (1 + 𝑖)12
𝒊 = 𝟎. 𝟎𝟓𝟎𝟐 = 𝟓. 𝟎𝟐%
5) What will be the total amount available 10 years from
now if $2,000 is deposited at the present time with
nominal interest at the rate of 6% compound semi-
annually?

P = $2,000
n = 10
r = 0.06 semi-annually, Compound interest
m = 2,
𝑟 𝑛.𝑚
𝑆 = 𝑃(1 + )
𝑚
0.06 10∗2
𝑆 = 2000 ∗ (1 + )
2
S = $𝟑, 𝟔𝟏𝟐. 𝟐
5) What will be the total amount available 10 years from
now if $2,000 is deposited at the present time with
nominal interest at the rate of 6% compound semi-
annually?
P = $2,000
n = 10
r = 0.06 semi-annually, Compound interest
m = 2,
Another solution:
2
𝑟 𝑚 0.06
𝑖𝑒𝑓𝑓 = (1 + ) −1 = 1 + − 1 = 0.0609
𝑚 2

𝑆 = 𝑃(1 + 𝑖𝑒𝑓𝑓 )𝑛 = 2000 ∗ 1 + 0.0609 10

= $𝟑, 𝟔𝟏𝟐. 𝟐
6) What will be the total amount available 10 years from
now if $2,000 is deposited at the present time with
nominal interest at the rate of 6% compound semi-
annually?
P = $2,000
n = 10
i = 0.06 semi-annually, Compound interest
m = 2,
r = 0.12
𝑟 𝑛.𝑚
𝑆 = 𝑃(1 + )
𝑚
0.12 10∗2
𝑆 = 2000 ∗ (1 + )
2
S = $𝟔, 𝟒𝟏𝟒. 𝟐𝟕
7) For the case of nominal annual interest rate of 20 %,
determine:
r = 0.2
(a) The total amount to which one dollar of initial principle
would accumulate after one year with continuous
compounding.
P = $1, n=1, S=?, continuous interest
𝑆 = 𝑃𝑒 𝑟.𝑛 = 1 ∗ 𝑒 0.2∗1 = $1.22
(b) The effective annual interest rate if compounding is
continuous.
𝑖𝑒𝑓𝑓 = 𝑒 𝑟 − 1 = 𝑒 0.2 − 1 = 0.22 =⇒ 22%