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Doyouknow,Ifsomeonewantstobuyabyke,oracostlymobileorifyourfatherwantstopurchaseanewflat,
theygeneralltakeloanfromabankorfromafinancier.Theyneedtopaymonthlyinstallments.Today,acrossthe
world,alltheEMI's(EquatedmonthlyInstallments)arebeingcalculatedoncompoundinterest.
Soafterreadingthisarticle,youmustbeinapositiontocalculatetheEMIyouaregoingtopayforyournewbyke
purchase!!
Beforethat,letustrytounderstandthemeaningofcompoundinganddiscounting.Weknowthatdailypricesofthe
goodsincreaseatarate.Assume,AproductwhichcostsRs.100costsRs.110nextyearandRs.121thatnext
year.Suppose,YoulendRs.100toyourfriendandhepromisedtogiveyouRs.100after1year.Doyouaccept
it?Outoffriendshipweaccept.Butthinklikeafinancier.IfyoureceiveRs.100after1yearthevalueofthis100
rupeemaynotbuythesameamountofgoodsitwouldhavepurchasedtodayasthepriceswentuptoRs.100.So
weneedtochargesomeinterest.Sohowmuchistheinterest?
Weusetheformulaofcompoundinterest.
P (1 +
) = A 100 (1 +
100
) = 110
100
Itisclearthatinterestrateis10%
Thatmeans,iftheinterestrateis10%,Rs.100todayisequaltoRs.110earnedafter1yearandRs.121after2
years.
Author:
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HowEMI'swork:
Ifabuyersellsaproducttoyouatfullpaymentgetsomeinterestonyouramountfornperiods.Thistotalamount
shouldequaltosumofallEMI'sandtheinterestsaccruedoneachEMIfortheremainingperiod.Thenonlythe
sellerdidnotgetanyloss.
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Assumewehavetakenaloanatperiod0andhavetopayinstallmentsattheendof1,2,3,4thperiodsofxeach.
NowloanamountplustheinterestonthetotalloanamountPatR%ratefor4periodsisequaltoalltheEMI'sand
interestsearnedfortheremainingperiod.ThatistheEMIintheperiod2earns2periodsinterestandEMIinthe
3rdperiodearnsonly1periodinterest.
P (1 +
= x(1 +
100
+ x(1 +
100
100
+ x(1 +
+x
100
WeshouldalsosolvethisproblembyPresentValue(PVmethod).Youlearnthisconceptinanyfinancetext
book!!
WealreadylearntthatRs.110earnedafter1yearisequaltoRs.100earnedtodayiftheinterestrateis10%
SoRs.110discountedat10%givesyouRs.100.Don'tworryhowtodothis.Thisisquitesimple.Youhaveto
calculatePfromthecompoundinterestformula.
A
P =
(1 +
100
HereA=Rs.110,R=10%,n=1.
Fromtheabovediagram,ifwehavetakenloanfor4periods,thelastinstallmentshoulddiscountfor4periodsand
soon.
SoP
=
(1 +
(1 +
100
+
(1 +
100
100
(1 +
100
1.ApersonborrowedasumofRs6000at10%p.a.,interestcompoundedannually.Ifthemoneyistoberepaidin
threeequalannualinstallment,eachpayableattheendoftheyear,thenwhatisthevalueofeachinstallment?
a.Rs.2,000b.Rs2,413c.Rs2,314d.Rs2,662
Sol:Sumborrowed=Rs6000
Interest=10%atcompoundedannuallyandtime=3years
Letxbetheamountpaidattheendofeachofthe3years.
6000(1 +
10
100
6000(1.1)
10
= x(1 +
+ x (1 +
100
10
)+x
100
= 1.21x + 1.1x + x
6000(1.331)
x =
= 2412.68
3.31
SoInstallmentamountisRs.2413
Tip:Usetheembeddedcalculatortocheckyouraccuracy.multiplyinterestratewith12anddivideyearswith12.
SoR=120,Period=0.25,LoanAmount=6000
2.Threeequalinstallment,eachofRs200,werepaidattheendofyearonasumborrowedat20%compound
interestcompoundedannually.Findthesum.
a.Rs600b.Rs400c.Rs421.30d.Rs432.10
Sol:InstallmentseachofRs200for3years.
20
x(1 +
100
x(1.2)
20
= 200(1 +
+ 200 (1 +
100
20
20
) + 200 (1 +
100
100
x(1.718) = 200(3.64)
200(3.64)
x =
= 421.3
1.718
AlternateMethod:
weusediscountingmethod.Wediscounttheinstallmentsforthepresentvalue.
200
P =
20
(1 +
200
(1 +
100
P =
200
1.2
200
20
200
100
+
1.44
20
(1 +
100
200
1.718
P=421.3
3.Amanborrowsacertainsumofmoneyandpaysitbackin2yearsintwoequalinstallments.IfC.I.isreckoned
at5%perannumandhepaysbackannuallyRs.441,whatsumdidheborrow?
a.Rs.820b.Rs.800c.Rs.882d.Rs.850
441
Sol:MoneyborrowedwhichbecomesRs.441afteroneyear=
(1 +
100
=441x(20/21)=Rs.420.
MoneyborrowedwhichbecomeRs.441aftertwoyears=
441
(1 +
=441x(20/21)x(20/21)=Rs.400.
)
100
Totalmoneyborrowed=Rs.820.
GeneralDiscussionOnEMI's:
SupposeyouhavetakenaloanofRs.100000tobuyahouseat12%ratetobepaidEMI'sfor60months.
TheyusethisformulaEMI=
P r (1 + r)
(1 + r)
Herer=Rate/1200
n=periods(5years=60periods)
SampleLoanSchedule:
CarWaleEMISchedule
FollowingScheduleIsFor:100000torepayin60months.
AllcalculationsarebasedonEMIinArrears(i.e.RearEndedEMI's).
Rs.2224
Rs.1000
Rs.1224
Rs.98776
2.
Rs.2224
Rs.988
Rs.1237
Rs.97539
3.
Rs.2224
Rs.975
Rs.1249
Rs.96290
4.
Rs.2224
Rs.963
Rs.1262
Rs.95028
5.
Rs.2224
Rs.950
Rs.1274
Rs.93754
Monthlyinterestis1%permonth.Nowafter1month,interestaccruedis1000.OfthetotalEMIofRs.2224,
Rs.1000usedforinterestandtheremainingRs.1224forprincipalreduction.NowBalanceofRs.98776becomes
theprincipalfornextmonth.Sointerestis987.7orRs.988.
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