ENGINEERING

ECONOMICS
CHAPTER 2
(Interest)
 Interest

What Is Interest?
Interest is the monetary charge for the privilege of
borrowing money, typically expressed as an annual percentage rate
(APR). Interest is the amount of money a lender or financial institution
receives for lending out money. Interest can also refer to the amount of
ownership a stockholder has in a company, usually expressed as a
percentage.
 Interest

• Interest is the monetary charge for borrowing money—generally

expressed as a percentage, such as an annual percentage rate
(APR).

• Key factors affecting interest rates include inflation rate, length of

time the money is borrowed, liquidity, and risk of default.

• Interest can also express ownership in a company.

Understanding Interest

Two main types of interest can be applied to loans—

simple and compound. Simple interest is a set rate on the
principle originally lent to the borrower that the borrower has to
pay for the ability to use the money. Compound interest is
interest on both the principle and the compounding interest paid
on that loan. The latter of the two types of interest is the most
common.
What Is Simple Interest?
Simple interest is a quick and easy method of calculating the
interest charge on a loan. Simple interest is determined by
multiplying the daily interest rate by the principal by the number of
days that elapse between payments.

This type of interest usually applies to automobile loans or

short-term loans, although some mortgages use this calculation
method.
 SIMPLE TERMS
INTEREST:
The amount of money paid for the use of money called the capital for a certain period of time.

SIMPLE INTEREST:
The interest to be paid which is proportional to the length of time the Principal used.

PRINCIPAL:
The amount of money used on which interest is charge.

RATE OF INTEREST:
The amount earned by one unit of principal during a unit of time.

ORDINARY INTEREST:
An interest based on the exact number of one bankers year which is equal to 12 months
One month = 30
One year = 360
 SIMPLE TERMS

EXACT INETEREST:
An interest based on the exact number of days, 365 for ordinary year and 366 for leap year

DISCOUNT:
Is the difference between the future worth and its present worth.

RATE OF DISCOUNT:
The discount on one unit of principal per unit of time
 SIMPLE INTEREST ( Formula)
The capital Originally invested in a transaction is called principal (p).
At any time after the investment of the principal, the sum of the principal
and the Interest due is called the amount (F).
F=P+I
I = Prt

Exact Interest for t days.

I = Pr (t/365)

Ordinary Interest for t days.

I = Pr (t/360)

Bankers Discount:
I = d/(1 – d)
 Formula for Simple Interest Simple Discount:

I = Prt I = Fdt
I = Interest I = Interest
P = principal F = Amount due at the end
i = Rate of Interest in decimal of time “t”
n = number of Interest period. D = Discount rate
F = Total Amount P+I=F
F=P+I P=F–I
F = P + Prt P = F – F dt
F = P(1+rt) P = F(1 – dt)
When t = 1( after 1 year)
F = P(1 + r)
 Equivalent rate of
Formula for Rate of Discount Interest.

d = rate of Discount d = 1/(1+i)

d = F – P1 d + di = I

d = 1- (1/1+i) i – di = d

d = 1/(1+i) (Rate of Discount) i(l – d) = d

I = d / (l – d) (rate of interest)
 EXAMPLE NO. 1

A price tag of P1,200.00 is payable in 60 days but if paid with

in 30 days it will have a 3% discount. find the rate of Interest.

Solution:
Discount = 3% or 0.03 I = Prt
0.03 (1200) = 36 I = P r t
1200 - 36 = 1164 36 = 1164 r (30/360)

r = 0.37 or 37% (rate of Interest)

 EXAMPLE NO. 2

A Bank cherges 12% simple interest on a P300.00 loan. How much

will be repaid if the Loan is paid back in one lump sum after three
years?

Solution:
A = P + Prt
A = 300 + 300(0.12)(3)
A = P408.00
 Example no.3
A man borrowed P2,000.00 from a bank and promise to pay the
amount for one year. He received only the amount of P1,920.00
after the bank collected an advance interest of P80.00. What was
the rate of discount and the rate of interest that the bank collected
in advance?
Solution:

Rate of discount = 80/2000 = 0.04 or 4%

Rate of Interest = 80/1920 = 0.0417 or

4.17%
 Compound Interest
What Is Compound Interest?
Compound interest (or compounding interest) is the interest on a loan or
deposit calculated based on both the initial principal and the accumulated interest
from previous periods. Thought to have originated in 17th-century Italy, compound
interest can be thought of as "interest on interest," and will make a sum grow at a
faster rate than simple interest, which is calculated only on the principal amount.
The rate at which compound interest accrues depends on the frequency of
compounding, such that the higher the number of compounding periods, the greater
the compound interest. Thus, the amount of compound interest accrued on $100
compounded at 10% annually will be lower than that on $100 compounded at 5%
semi-annually over the same time period. Because the interest-on-interest effect can
generate increasingly positive returns based on the initial principal amount,
compounding has sometimes been referred to as the "miracle of compound interest."
 Compound Interest

How Compound Interest Works

Compound interest is calculated by multiplying the initial
principal amount by one plus the annual interest rate raised to the
number of compound periods minus one. The total initial
amount of the loan is then subtracted from the resulting value.

The formula for calculating the amount of compound interest is

as follows:
Compound interest = total amount of principal and interest in future (or
future value) less principal amount at present (or present value)
 Compound Interest

Compound Interest
The interest earned by the principal which is added to the principal will also
earn an interest for succeeding periods.
Interest Period Principal Interest Earned Compound Interest at he period
1 P Pi P + Pi = P (1+I)
2 P(1+I) P(1+i) I P(1+i)+P(1+i)I = P
3 P Pi P+PI=P
 Compound Interest
When n = 3 F=P
P = present worth Principal F = Compound amount at end of “n” period
i = rate of interest n = no. of period s
= Single payment compound amount Factor F=P

1. For 8% compounded annually for 1 year

i = 0.08 n = 1period
2. For 8% compounded semi – annually for 1 year
i = 0.08/2 = 0.04 n = 1(2) = 2 periods
3. For 8% compounded quarterly for 1 year
i = 0.08/4 = 0.02 n = 1(4) = 4 periods
4. For 8% compounded monthly for 1 year
i = 0.08/12 = 0.0067 n = 1(12) = 12 periods
5. For 8% compounded bi – monthly for 1 year
i = 0.08/6 = 0.013 n = 1(6) = 6 periods
 Example no.1

How long will it take money to double itself if invested at 5%

compounded Annually?

Solution:
A = P (1+i)ᶯ
2P =P(1.05)ᶯ
log2 = ᶯ log1.05
ᶯ = log2 / log1.05
= 0.301 / 0.021
ᶯ = 14 years
 Example no.2

John borrowed P50,000.00 from the bank at 25%compounded

semi-annually. What is the equivalent effectiverate of interest?
Solution:
Effective rate of interest
(1+i)ᶯ -1
i = 0.25/2
i = 0.125

Effective rate of Interest = (1.125)² -

1
= 0.2656 or 26.56%
 Example no.3
The amount of P50,000.00 was deposit in the Bank earning an
interest of 7.5% per annum. Determine the Total amount at the
end of 5 years, if the Principal and Interest were not withdrawn
during the period?

Solution:
F = P (1+i)ᶯ

F = 50000 (1.075)ƽ

F = P71,781.47
 Example no.4

Find the present worth of a future payment of P300,000.00 to be

made in 5years with an Interest rate of 8% per annum.
Solution:
F = P(1+i)ᶯ

300000 = P(1.08)ƽ
P = 204,174.96
ANY QUESTION?
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