GE301

INTEREST AND DISCOUNT

INTEREST
• The amount of money paid for the use of borrowed capital.
• For the lender interest is the income produced by the money
which he has lent
SIMPLE INTEREST
• The interest to be paid is directly proportional to the length of
time the amount or principal is borrowed.
• Principal – the amount of money borrowed
• Rate of interest – the amount earned by one unit of principal
during a unit of time.
I = Pin (Eqn 1)
Where: I = total interest earned by the principal
P = amount of the principal
n = number of interest periods

F =P + I = P( 1 + iN) (Eqn. 2)
Where F = the total amount to be repaid
ORDINARY AND EXACT SIMPLE INTEREST
• Ordinary
  simple interest – computed on the basis of one’s
banker’s year, which is
1 banker’s year = 12 months, each consisting of 30 days
= 360 days
Exact simple interest – based on the exact number of days,
365 for an ordinary year and 366 days for a leap year.

If d is the number of days in the interest period, then

Ordinary simple interest = Pi (Eqn. 3)

Exact simple interest = Pi for ordinary year (Eqn. 4)

= Pi for leap year
Sample Problems: Simple interest
• Example 1.
Determine the exact and ordinary simple interests on P5,000 for
the period from January 15 to June 20, 1993, if the rate of
simple interest is 14%.

• Example 2.
A man borrows P10,000 from a loan firm. The rate of simple
interest is 15%, but the interest is to be deducted from the loan
at the time the money is borrowed. At the end of one year he to
pay back P10,000. What is the actual rate of interest?

• Example 3.
A man borrows P6,400. from a loan association. In repaying this
debt he has to pa P400 at the end of every 3 months on the
principal and a simple interest of 16% on the principal outstanding
at that time. Determine the total amount he has paid after paying all
his debt.
COMPOUND INTEREST
• The interest earned by the principal is not paid at the end of
each interest period, but is considered as added to the
principal, and therefore will also earn interest for the
succeeding periods.
• The total amount earned :
F = (1 + i)n (Eqn. 5)

The factor (1 + i)n is called “Single Payment Compound Amount

Factor”
(1 + i)n = (F/P, i%, n) (Eqn. 6)

F = P (1 + i)n = P (F/P, i%, n) (Eqn. 7)

Derivation of formula (Eqn. 5)
Interest Principal at the Interest Compound amount at the end
Period beginning of the earned during of period
period period
1 P(1 + i) Pi P + Pi = P(1 + i)
2 P(1 + i)2 P(1 + i)i P(1 + i) + P(1 + i)I = P(1 + i)2
3 P(1 + i)3 P(1 + i)2i P(1 + i)2 + P(1 + i)2i =P(1 + i)3
… … … …
n P(1 + i)n P(1 + i)n-1i P(1 + i)n-1 + P(1 + i)n-1i =
P(1 + i)n = F

COMPOUND INTEREST
• If r is the nominal annual interest rate and m is the number of
interest periods each year, then the interest rate per interest
period is i = r/m, and the number of interest periods in n years
is mn.
F = P(1 + r/m)mn Eqn. 8
F = Pern Eqn. 9
Nominal Interest Rate
• For compound interest, the rate of interest usually quoted is
nominal rate of interest which specifies the rate of interest
and the number of interest periods per year.
Effective Rate of Interest
• Is the actual rate of interest on the principal of one year.
• It is equal to the nominal rate if the interest is compounded
annually, but greater than the nominal rate if the number of
interest periods per year exceeds one, such as for interest
compounded semi-annually, quarterly or monthly.

Effective rate of interest = F1 – 1 = (1 + i)n – 1 Eqn. 10

Present Value
 • The principal P in the formula F = P(1 + i)n may be considered
as the value of the compound amount F at present, or it is the
amount which when invested now will become F after n
periods. P is called the present value of the amount F.
P = F(1 + i)-n = Eqn. 11
Discount
• The
  difference between what is worth in the future and its
present worth

Discount = Future Value – Present Value Eqn. 12

Rate of Discount is the discount in one unit of principal per unit

of time
d = 1 - = 1 – (P/F, i%, 1) Eqn. 13
d = = (P/F, i%, 1)i Eqn. 14
For equivalent rate of interest corresponding to a rate of interest
i,
i= =
Sample Problems: Compound Interest
• Example 1.
If the sum of P12,000 is deposited in an account earning interest
at the rate of 9% compounded quarterly, what will become at
the end of 8 years?

• Example 2.
At a certain interest rate compounded quarterly, P1,000 will
amount to P4,500 in 15 years. What is the amount at the end of
10 years?

• Example 3.
Compare the accumulated values at the end of 10 years if P100
is invested at the rate of 12% per year compounded annually,
semi-annually, quarterly, monthly, daily and continuously.
Additional Problems
• Example 1.
A man wishes to bequeath to his daughter P20,000 ten years from
now. What amount should he invest now if it will earn interest of
8% compounded annually during the first 5 years and 12%
compounded quarterly during the next 5 years?

• Example 2.
A company expects to retire an existing machine at the end of
1993 and will replace it with new machine for the same task at an
estimated cost of P60,000. the old machine is expected to be sold
for P5,000 when it is replaced. To provide for replacement, the
company intends to deposit the following amounts in an account
earning interest at 8% compounded quarterly:
P20, 000 at the end of 1900
P15, 000 at the end of 1991
P10, 000 at the end of 1992