CHAPTER 2: INTEREST FORMULAS

The interest owed upon repayment of a loan is proportional to the length of time the principal sum has been borrowed.

Where: I = Interest earned P = Principal amount n = interest period i = interest rate

Example 2.1: What amount will be owed in 5 years if RM 5000 is borrowed now at 10% per year simple interest?

Compound interest is calculated and payable at the end of each interest period. If the borrower fails to pay the interest earned at the end of each period, and interest is charged on the total amount owed, the interest is said to be compounded.

To aid in identifying and recording the economics effects of investments Cash flow directions depends on the point of view taken on each case (borrower or lender).
RM 1160 RM 160

RM 1000

RM 160 RM 1160 a) Borrower RM 1000 b) Lender

Interest formulas derived in this section apply to the common situation of annual compounding interest and annual payments. The symbols used are: i = the annual interest rate n = the number of annual interest periods P = a present principal amount A = a single payment, in a series of n equal payments, made at the end of each annual interest periods F = a future amount, n annual interest periods

There are 4 important points applied in the derivation: The end of one year is the beginning of the next year. P is at the beginning of a year at a time regarded as being the present. F is at the end of the nth year from a time regarded as being the present. An A occurs at the end of each year of the period under consideration. When P and A involved, the first A occurs one year after P When F and A involved, the last of A occurs simultaneously with F

i.

ii. iii.
iv.

Has two methods of solving: using the factor interest tables; designation and the

1.

2.

using equation:

Example2.2:
Daniel borrowed RM 5000 from a bank at 12% compounded annually for 5 years. What is the compounded amount at the end of the fifth year? Show the cash flow diagram.

The single-payment compound-amount relationship may be solved for P as follows:

P value can also be obtained using the factor designation and the interest tables;

Example 2.3: How much must be invested now at 16% compounded annually so that RM 1811 can be received 4 years hence?

Solving F using:

Or using the equal-payment-seriescompound-factor designated as:

Example 2.4: If you invest RM 1000 per year, how much is the earning at the end of year 8 if it is compounded 10% annually?

Solving A using:

Or using the equal-payment-series-sinking fund-factor designated as:

Solving A using:

Or using the equal-payment-series capitalrecovery factor designated as:

Solving P using:

Or using the equal-payment-series presentworth factor designated as:

Example 2.5: What is the present worth of a series of ten equal annual payments of RM 500 at an interest rate of 12% is compounded annually?

Sometimes, periodic payments do not occur in an equal series. It may increase and decrease by a constant amount. Solving A using:

Or;

To solve P:

Or;

Where: G = annual change or gradient n = the number of years A = the equal annual payment P = present principal amount

Example 2.6: The office space rental rate was at RM 500 during the first year and was increased at RM 100 every year for 5 years. If the interest rate was compounded annually at 8%, determine: a) the present principal amount, P b) the annual equal amount, A

Example 2.7: Mr Tan deposited his money in a saving account in the bank at the amount of RM 20000 with 12% compounded annually. How much is his total money at the end of 10 years? Sketch the cash flow diagram.

Example 2.8: If you deposit RM 2000 annually into your bank account for 4 years, what is the balance in your bank account if the investment rate is 10% compounded annually? Sketch the cash flow diagram.

Example 2.9: A person lends RM 10 000 at 8% simple interest for 5 years. At the end of this time, the entire amount (principal plus interest) is invested at 12% compounded annually for 10 years. How much will accumulate at the end of the 15 year period? Sketch the cash flow diagram.

In some situations, annual payment may increase or decrease, and not by a constant amount, but by a constant percentage.

By considering the single-payment as G: a)

b)

Example 2.10 The maintenance cost of a machine is RM990 for the first year and was increased by 10% per year until the end of the 6th year. Find the P value if the interest rate is: a) 15% b) 10%

Example 2.11: Rose bought a piece of land with an upfront payment of RM 15000 and an installment of RM 1000 per year for 6 years. However, because of some cash problems, she stopped paying for 3 years from now. How much is the present land value if it is compounded at 10% annually?

Example 2.12:
Consider the cash flow diagram below. Determine the present value if it was compounded annually at 12%.

Example 2.13 Consider the cash flow diagram below. What is the value of P?

Example 2.14:

Information on a machine is as follows: i. The selling price after 10 years is RM30000 ii. Total revenue from the product is RM12000 per year iii. Maintenance cost from year 1-5 is RM10000 iv. Repair cost at year 5 is RM10000 v. Maintenance cost for year 6 to 10 are: Determine the P value if i = 10%
Year 6 7 8 9 Amount (RM) 5000 6000 7000 8000 Hint: if (P/G, 0.1, 10) = 22.891 (P/G,0.1,6) = 9.684 (P/G, 0.1, 5) = 6.862

10

9000

End of Chapter 2