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 CHAPTER 7
Simple Interest

Chapter Overview

Simple interest is paid on short-term savings certificates, and simple interest is calculated
on short-term loans. With simple interest, the principal stays the same. The amount of
interest I earned on short-term savings vehicles is a function of the principal P (original
amount invested), the annual interest rate r, and the interest period t in years. The basic
equation for calculating simple interest is:

Interest = Principal × Rate × Time

I = Prt

This formula can also be used to calculate interest on short-term loans. Since r is the
nominal annual interest rate, the time must be expressed in years as well. If the time is
given in months or days, the time must be converted to years. This can be done by
dividing the number of months by 12 or the number of days by 365. Present examples
to the students for these conversions. If the interest rate is 4%, and the time is six
months, then t = 6 /12 = 0.5 . If the interest rate is 4% and the time is 230 days, then
t = 230 / 365 . Note that an exact year of 365 days is used in the denominator.

There are a variety of methods that can be used for counting the number of days between
two given dates. Pointers and Pitfalls on pages 261-262 describes the use of the TI BAII
Plus financial calculator to do this using the DATE function. The Excel function
COUPDAYSNC on MathXL at www.mathxl.com can be used. The Excel function
ACCRINT on MathXL can be used to find the interest when the time is in days. Refer
the student to MathXL to learn about manual techniques for counting the number of days
between two dates. The manual techniques could also be introduced in a class lecture.
You need to recall the number of days in each month. The “count the first day but not the
last day” is a commonly used approach for manual counting.

The formula I = Prt can also be used as the starting point for setting up formulas for
finding values of P, r, and t.

The future value S of an investment or loan is the sum of the original principal plus
interest. This leads to the formula S = P + Prt = P (1 + rt ) .

Copyright © 2012 Pearson Education Canada

Instructor’s Resource Manual 77

In this chapter, the concept of present value is introduced for the first time. This concept
will surface at many places in the text and is crucial to understanding the world of
finance. Interest is paid for the use of money; thus money has time value. It is
worthwhile to allocate sufficient time to develop the present value concept through a
discussion of the examples and problems presented in the text. The formula
P = S / (1 + rt ) can be used to find present value. Note this formula can be derived from
the formula for S.

The concepts of present value and future value lead into dated or equivalent values.
Examples are provided for finding the equivalent value of a single payment or the value
of two or more equivalent payments. In finding equivalent values, the important decision
at any point is whether to use the formula for finding S (future value) or the formula for
finding P (present value). A practical application of present value and dated values is the
loan repayment problem discussed at the end of the chapter.

Learning Objectives

After studying Chapter 7, your students will be able to:

1. Compute the amount of simple interest using the formula I = Prt .

2. Compute the principal, interest rate, or time using variations of the
formula I = Prt .
3. Compute the maturity value (future value) using the formula S = P (1 + rt ) .
S
4. Compute the principal (present value) using the formula P = .
(1 + rt )
5. Compute equivalent or dated values for specified focal dates.

Suggested Priority of Chapter Topics

Must Cover

• Simple interest and I = Prt

• Calculation of P, r, and t using I = Prt
• Calculation of future value
• Definition of present value
• Calculation of present value
• Equivalent (dated) values

Recommended

• Loan repayment problem

Copyright © 2012 Pearson Education Canada

78 Instructor’s Resource Manual

Chapter Outline

Objective 1: Compute the amount of simple interest using the formula I = Prt.

A. If money is borrowed, interest is charged. If money is invested, interest is paid

for the use of the money. Simple interest is paid on short-term investments or
loans. A distinguishing characteristic of simple interest is that the base for
calculating the interest is constant. The formula I = Prt can be used for
calculating interest.

B. The symbols can be defined.

I interest
P original amount invested or borrowed
r simple annual rate of interest
t time in years

C. Present examples for finding interest. Divide by 12 if the time is in months and
divide by 365 (exact year) if the time is in days.

1) $4000 at 5¼ % for 9 months I = 4000 × 0.0525 × ( 9 /12 ) = $157.50

2) $3000 at 6% for 92 days I = 3000 × 0.06 × ( 92 / 365 ) = $45.37

D. The time may be expressed by giving two dates.

1) $2000 at 5% from November 1, 2009, to December 15, 2009

The value of t must be determined as the number of days between dates. The
Chapter Overview outlines methods for finding the number of days t. If the
“count the first day but not the last day” approach is used, you would count
November 1 but not December 15. This would give 30 + 14 = 44 days. Manual
techniques, as mentioned in the Chapter Overview, are discussed on MathXL.

The interest can now be calculated. I = 2000 × 0.05 × ( 44 / 365 ) = $12.05

Copyright © 2012 Pearson Education Canada

Instructor’s Resource Manual 79

Objective 2: Compute the principal, interest rate, or time using variations of the
formula I = Prt .

A. The student need only remember the formula I = Prt because formulas for P, r,
and t can be derived from I = Prt . Ask the students to explain the algebra behind
the derivations.

Teaching Tip
Present the diagram shown in Pointers and Pitfalls on page 265 as a tool for
remembering the formulas derived from I = Prt .

B. Consider the derived formula r = I / ( Pt ) . The result r will appear as a decimal

and can be converted to a percent. The value of r will be an annual rate of
interest.

C. Consider the derived formula t = I / ( Pr ) . The result t will be in years. If the

time is requested in months multiply t by 12. If the time is requested in days,
multiply t by 365.

D. The principal can be found using the derived formula P = I / ( rt ) . In the

formulas for calculating P and t, r should be converted to a decimal.

Objective 3: Compute the maturity value (future value) using the

formula S = P (1 + rt ) .

A. The maturity value of a loan is equal to the original principal borrowed plus
interest owed on the loan.

B. The maturity value of an investment is the original principal invested plus interest
earned on the investment.

C. The formula Future Value = Principal + Interest can be expressed as

S = P (1 + rt ) . The symbol S is used in this chapter to represent future value.

D. Present the student with a variety of examples and problems to get familiar with
the use of this formula. Emphasize that S includes both principal and interest.
To find the interest earned, subtract the original principal from S.

Example: You invest $2500 in a short-term deposit at 4% for 91 days. What will
be the future value of this investment and interest earned?

Copyright © 2012 Pearson Education Canada

80 Instructor’s Resource Manual

S = P (1 + rt )
⎡ ⎛ 91 ⎞ ⎤
S = 2500 ⎢1 + 0.04 ⎜ ⎟⎥
⎣ ⎝ 365 ⎠ ⎦
S = $2524.93

I = Prt
I = 2524.93 − 2500
I = $24.93

Teaching Tip
In using the formula S = P (1 + rt ) , note the order of operations. The product of r
and t is found first and 1 is added to this product. Then the value of 1+ rt is
multiplied by P, the principal. Note that 1 is a constant in the formula.

S
Objective 4: Compute the principal (present value) using the formula P = .
1 + rt

A. Because interest is paid on funds, money has time value. This leads to the
following formal definition of present value as presented in the text. The present
value of an amount at any given time is the principal needed to grow to that
amount at a given rate of interest over a given period of time.

B. The definition in (A) can be analyzed. Note that present value is equated with
the word principal. The rate of interest and time period of the investment both
affect the present value. The goal is to find the present value of an amount
S (future value) stated at a given time.

C. Since present value is equated with principal, you can derive the formula for the
present value or principal from the formula S = P (1 + rt ) . Dividing both sides by
S
(1+ rt ) gives P = .
1 + rt

D. The use of line diagrams or time graphs can be helpful in solving problems for
finding present value. Line diagrams are used in text examples. The time graph
is a vehicle for helping the student sort out the data in the problem.

E. The student may query: How do I know when I need to find the present value?
There are key words or phrases to identify that you are looking for present value.
Consider the examples given below showing different ways of asking for the
present value.

What principal will have a future value of $10 000?

Copyright © 2012 Pearson Education Canada

Instructor’s Resource Manual 81

What amount of money will accumulate to $20 000?

Compute present value of $6 000.
Compute amount of money that will grow to $5 000.
Find the amount paid for an investment that will mature at $20 000.
How much money was borrowed if the maturity value of the loan is $30 000.

F. Present an example using time graphs. What amount of money will accumulate to
$595.67 in 60 days at 4% interest? The maturity value S of $595.67 is given in
the problem. You are asked to find the principal or present value given an interest
rate of 4%, and a time of 60 days. Set up a time graph and use the formula for
finding P or present value.

Present Value P Maturity Value

$591.78 $ 595.67

595.67
P= = $591.78
1 + 0.04 ( 60 / 365 )

Objective 5: Compute equivalent or dated values for specified focal dates.

A. The concept of a dated value or equivalent value can be illustrated by setting up a

table such as is found on page 277. This table could be built with the help of the
students. Start out with a principal amount of $5000 and an interest rate of 5%.
Calculate the value of the investment 3 months, 6 months, 9 months, and 1 year
from today. The formula S = P (1 + rt ) can be used to calculate the future values.

Time Dated Value (Future Value)

Today 5000.00
3 months from today 5062.50
6 months from today 5125.00
1 year from today 5250.00

Notice that $5000 today has a different value at 3 months, 6 months, and 1 year
due to the interest earned over varying time periods. In order to compare
monetary values at different points in time, it is necessary to pick a focal date.
The focal date is a set date used to find equivalent values. If equivalent values
can be found as of the same date or focal date, then you have a base for
comparing values.

B. In finding equivalent values as of a set focal date, the central question is : Do I

use the formula for future value S or the formula for present value P?

Copyright © 2012 Pearson Education Canada

82 Instructor’s Resource Manual

The following rule as found in the text can be used to answer this question. The
due date is the date on which the payment falls. The focal date is the set
comparison date. Explore the logic of the rule with the student.

1) If the due date falls before the focal date, use the future value (maturity value)
formula for S.
2) If the due date falls after the focal date, use the present value formula for P.

C. Present some examples to the students.

Example #1: A debt can be paid off by a payment of $400 six months from today
and a second payment of $600 one year from today. Find a single payment today
that would suffice to pay off the loan. The interest rate is 6%.

t=0 6 months one year

P $400 $600

Since it is desired to find a single payment today, the focal or set comparison date
will be today at t = 0. Because the due date of six months for the $400 payment
falls after the focal date of t = 0, use the present value formula for finding the
equivalent value of $400 at t = 0. Because the due date of one year for the $600
payment falls after the focal date at t = 0, use the present value formula for
finding the equivalent value of $600 at t = 0.

Single Equivalent Payment 400 600

= +
( at t = 0 ) 1 + 0.06 ( 6 /12 ) 1 + 0.06 (12 /12 )
= 388.35 + 566.04
= $954.39

A single payment today of $954.39 will repay the two payments.

If a payment is interest-bearing, the future value of the payment should be

calculated first. Then the future value can be placed on the diagram. If the $400
payment were earning interest at 5% per annum, you would calculate the future
value as of six months. The future value would be 400 ⎡⎣1 + 0.05 ( 6 /12 ) ⎤⎦ = $410 .
The amount $410 would be placed on the diagram at six months.

Copyright © 2012 Pearson Education Canada

Instructor’s Resource Manual 83

Example #2: Present an example that involves using both the future and present
value formulas. A debt has been structured to be paid off with a payment of $500
three months from today and a payment of $800 nine months from today. What
single equivalent payment made six months from today will be sufficient to pay
off the two debts? The interest rate is 12%.

t=0 3 months 6 months 9 months

$500 ? $800

The focal date is six months. The due date of the $500 payment is three months,
which comes before the focal date so use the future value formula for $500. The
due date of nine months for the $800 payment comes after the focal date so use
the present value formula for $800.

Single Equivalent Payment 800

= 500 ⎡⎣1 + 0.12 ( 3 /12 ) ⎤⎦ +
at t = 6 months 1 + 0.12 ( 3 /12 )
= 515 + 776.70
= $1291.70

A single payment of $1291.70 will repay the two debts.

Copyright © 2012 Pearson Education Canada

84 Instructor’s Resource Manual

D. The loan repayment problem is discussed as an application of equivalent

values. Blended payments involve equal periodic payments consisting of both
interest and repayment of principal. The sum of the present values of the periodic
payments must equal the original principal. The student can let the unknown
payment be X. Since the focal date is at t = 0 , the present value of each payment
X can be found. The sum of the present values is set equal to the original loan.

Example: A loan of $1200 will be paid off with three equal payments made at 3,
6, and 9 months. The interest rate is 9%. Find the value of the periodic payment.

t=0 3 months 6 months 9 months

$1200 X X X

X X X
1200 = + +
1 + 0.09 ( 3 / 12 ) 1 + 0.09 ( 6 / 12 ) 1 + 0.09 ( 9 / 12 )

X X X
1200 = + +
1.0225 1.045 1.0675

1200 = 0.977995 X + 0.956938 X + 0.936768 X

1200 = 2.871701X

X = $417.83

Teaching Tip
To simplify the equation, find the reciprocal of each coefficient of X. Find the values of
1/1.0225, 1/1.045, and 1/1.0675.

Copyright © 2012 Pearson Education Canada

Instructor’s Resource Manual 85

Assignment Grid

Assignment Topic(s) Learning Estimated Level of

Objectives Time in Difficulty
Minutes
Ex. 7.1 A, B, C Calculating 1 45-50 Easy
simple interest
Ex. 7.2 A Finding P, r, t 2 20-30 Easy
Ex. 7.2 B Finding P, r, t 2 50-60 Medium
Ex. 7.3 A, B Computing 3 50-60 Medium
maturity value
Ex. 7.4 A Calculating 4 20-30 Easy
present value
Ex. 7.4 B Calculating 4 50-60 Medium
present value
Ex. 7.5 A Equivalent values 5 60-70 Medium
Ex. 7.5 B Equivalent 5 70-90 Difficult
(odd numbers) Values
Review Simple interest, 1,2,3,4,5 90-100 Difficult
Exercise present value,
future value,
equivalent values
Case Study 7.1 Future and 1,3,4,5 45-50 Medium
equivalent values

Copyright © 2012 Pearson Education Canada

86 Instructor’s Resource Manual

Name___________________Date______________Section_______

CHAPTER 7
TEN-MINUTE QUIZ

Circle the letter of the best response.

1. Tom has invested $1600 in a 90-day savings certificate paying an annual interest rate
of 4½ %. Find the interest earned.
a) $20.00
b) $18.00
c) $15.78
d) $17.75

2. What principal must be invested at an annual interest rate of 3% for 180 days to earn
$35.75 interest?
a) $2248
b) $1192
c) $2383
d) $2416

3. Find the rate of interest required for a principal amount of $869.70 to earn $32.90
interest if the funds are invested for three months?
a) 13.5%
b) 10.2%
c) 15.1%
d) 14.2%

4. Find the present value of $1270 due in 60 days if money is worth 6.2%.
a) $1210.00
b) $1282.94
c) $1257.19
d) $1246.32

5. For how many days must a principal of $1500 be invested at 5% per annum to earn
$46.25 in interest?
a) 61 days
b) 225 days
c) 52 days
d) 215 days

Copyright © 2012 Pearson Education Canada

Instructor’s Resource Manual 87

6. What amount must be invested to accumulate to a value of $11 900 in 180 days if the
interest rate is 7%?
a) $11 502.91
b) $11 489.20
c) $11 487.58
d) $11 603.48

7. You have invested $2500 in a 30-day savings certificate paying 4.15% per annum.
Find the amount of the investment at the end of 30 days.
a) $2551.88
b) $2508.53
c) $2491.50
d) $2603.75

8. Consider a payment of $600 due in six months from today. Find the equivalent value
at two months if the interest rate per annum is 5.5%
a) $600.00
b) $589.20
c) $594.55
d) $583.94

Answers:
1. d 2. d 3. c 4. c
5. b 6. a 7. b 8. b

Additional Questions:

1. How much interest is owed on a debt of $2100 borrowed at 5.25% for 90 days?
a. $99.23
b. $27.18
c. $5.25
d. $122.50

2. How many days will it take for $1900 to earn $43.73 in interest at 7% p.a.?
a. 30 days
b. 760 days
c. 33 days
d. 120 days

Copyright © 2012 Pearson Education Canada

88 Instructor’s Resource Manual

3. What is the maturity value of $1500 invested for at 6.75% from May 1, 2011 to
September 23, 2011?
a. $1540.22
b. $2153.08
c. $1538.83
d. $1902.23

4. What amount of money will accumulate to $1275.75 in 280 days at 5.4%?

a. $1577.83
b. $1222.90
c. $1225.00
d. $1328.60

5. Loan payments of $500 due today and $400 due in 9 months are to be combined
into a single payment 6 months from now. What single payment will settle the
two debts if interest on the loans is 6% and the focal date is 6 months from now?
a. $927.00
b. $450.00
c. $919.00
d. $909.09

6. A loan in the amount of $1800 is to be settled by two equal payments due in 5

months and 9 months. What is the value of the two equal payments if money is
worth 5.8% and the focal date is today?
a. $930.37
b. $921.75
c. $939.15
d. $929.45

7. Consider a payment of $850 due 4 months from today. Find the equivalent
payment at 6 months if the interest rate per annum is 7.2%.
a. $839.92
b. $860.20
c. $880.60
d. $859.96

8. What was the rate of interest if the interest on a loan of $875 was $19.56
after 120 days?
a. 2.6%
b. 6.8%
c. 6.4%
d. 7.3%

Answers:
1. b 2. d 3. a 4. c
5. d 6. a 7. b 8. b

Copyright © 2012 Pearson Education Canada

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