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SImpIe und Compound InLeresL ProbIems

Simple und Compoond Interest


The lending and borrowing of money has been happening since thousands of years. Any sum of money, borrowed for
a certain period, will invite an extra cost to be paid on the money borrowed, this extra cost at a fixed rate is called
interest. The money borrowed is called principal. The sum of interest and principal is called the amount. The time for
which money is borrowed is called period.
Amount = Principal + !nterest
The interest paid per hundred (or percent) for a year is called the rate percent per annum. The rate of interest is
almost always taken as per annum, in calculations we will always consider it per annum unless indicated.
The interest is of two types, one is simple, the other is compound:
Simple interest
!t is the interest paid as it falls due, at the end of decided period (yearly, half yearly or quarterly), the principal is said
to be lent or borrowed at simple interest.
Simple !nterest, S! = PRT / 100
Here P = principal, R = rate per annum, T = time in years

Therefore Amount, A = P + PRT/100 = P |1 + ( RT / 100 )]
!f T is given in months, since rate is per annum, the time has to be converted in years, so the period in months has
to be divided by 12. if T = 2 months = 2/12 years)
Example 1: Find the amount on S.!. when Rs 4000 is lent at S p.a. for S years.
By the formula, A = P (1 + RT/100) = 4000( 1 + S x S/100 ) = Rs S000
Compound !nterest
The compound interest is essentially interest over interest. The interest due is added to the principal and that
becomes the new principal for the interest to be levied. This method of interest calculation is called compound
interest, this can be for any period (yearly, half yearly or quarterly) and will be called Period compounded" like
Yearly compounded or quarterly compounded and so on.
First period's principal + first period's interest = second period's principal
Compound interest = principal {1 + Rate/100}time Principal
C! = P { 1 + R/100 }T - P
Here Amount = principal {1 + Rate/100 }time
Example 2: Find the compound interest on Rs 4S00 for 3 years at 6 per annum
Using the formula, A = P (1 + R/100)T = 4S00(1 + 6/100)3 = 4S00 (1.06)3 = S360
Compound interest = S360 - 4S00 = Rs 860
THE RULE OF 72
The rule of 72 is a quick way to show how long it will take to double your money under
The equation for the rule of 72 is:
Number of years for money to double = (72/Annual !nterest Rate) interest rate
At 8 interest, it will take 72/8 = 3 years for your money to double.
Here are more examples:
At 6, it will take 12 years ( 72/6 = 12)
At 12, it will take 6 years ( 72/12 = 6)
The rule of 72 is a short cut to estimate the magic of compound interest that makes your money grow.
- Remember that the rule of 72 is an approximation and its accuracy reduces as the interest rate becomes high.
!mportant notes
1. !n case interest is paid half yearly, then the interest is divided by 2, and used as (R/2) in the formula and the time
is multiplied by 2, and used as 2T in the formula, given by A = P | 1 + ( R / 200 ) ]2T
Example 3: Find the compound interest on Rs S000 for 3 years at 6 per annum compounded half yearly.
Using the formula, A = P | 1 + ( R / 200 ) ]2T
= S000(1 + 6/200)3x2
= S000 (1.03)6 = S371
Compound interest = S371 - S000 = Rs 371

2. !n case interest is paid quarterly, then the interest is divided by 4, and used as (R/4) in the formula and the time
is multiplied by 4, and used as 4T in the formula, given by A = P | 1 + ( R / 400 ) ]4T payable quarterly (rate = R/4,
time = 4T)
Example 4: Find the compound interest on Rs S000 for 3 years at 6 per annum compounded quarterly.
Using the formula, A = P | 1 + ( R / 200 ) ]2T
= S000(1 + 6/400)3x4
= S000 (1.01S)12 = S378
Compound interest = S378 - S000 = Rs 378
3. !n case the rates are different(R1, R2, R3..) for different years, the amount is given by P{1 + R1/100}{1 +
R2/100}{1 + R3/100}
Example S: Find the compound interest on Rs S000 for 3 years at 6 per annum for first year, 7 for the second
year and 8 for the third year
Using the formula, P{1 + R1/100}{1 + R2/100}{1 + R3/100}
= S000(1 + 6/100) (1 + 8/100) (1 + 3/100)
= 612S
Compound interest = 612S - S000 = Rs 112S
4. For population increase the formula to be used is P {1 + R/100 }T, and for decrease P { 1 R/100 }T. !t can also
be used for depreciation factor.
Example 6: The death rate of a town with population of 100000 is S , considering there are no new births, what is
the population of town in next three years?
Using the formula, P { 1 R/100 }T
= 100000(1S/100)3
= 100000(0.8S7) = 8S738
S. !n case the period is a fraction like 3 and years, or a and b/c years, then the amount should be calculated by
this formula
A = P { 1 + R/100 }3{1+(1/2 x R)/100}
Or A = P { 1 + R/100 }a{1+(b/c x R)/100}
Example 7: The birth rate of a town with population of 100000 is S , considering there are no deaths in the town,
what is the population of town in next three years and fours months?
Three years and four months mean 3 1/4
Using the formula, A = P { 1 + R/100 }a{1+(b/c x R)/100}
= 100000(1+S/100)3(1+ x S/100)
= 100000(1.1S7) (1.012)
= 117210 will be the population
6. The S! and C! earned during the first period remains the same.
Example 8: The compound interest on a certain sum of money in 2 years is 210 and the simple interest on the
same amount is 200, what are the principle and the rate of interest
Since S! and C! for first year is the same, and S! for each year is the same, so S! for the first year = 200/2 = 100, C!
for year ! = 100, that means C! for the year !! = 210 - 100 = 110. Here the excess of interest over year ! = 10.
Since the excess of interest in C! is interest over first years interest, assuming ! is the interest, !/100 x 100 = 10, so !
= 10, and the principal is obviously 1000.(calculate yourself)

Example 3: A sum of money placed at Compound !nterest doubles in every S
years, then in how many years it will become 16 times?
Now, it is given that the principle gets doubled in every S years.
So, if we start from initial amount P, then in first S years it will become 2P.
!n the next S years 2P will become 4P, next S years 4P will become 8P and finally
in next S years 8P will become 16P.
So, it will take (S+S+S+S) = 20 years.

Net present value (NPv)
Noney received or paid today is not the same as money received or paid after a period. This is because the money
has an opportunity cost of interest in the same period. What it simply means is that you can earn interest on money
if you have it now, and if you get the money later, you loose the opportunity to make interest on that. For example,
if the going interest rate in the market is 10, and someone has to pay me Rs. 1000, and he pays after an year, so
he should pay, 1100 (100 has the interest), Here 1100 is called the future value and 1000 is called the present value.
Here the Future value (Fv) = Present value (Pv) {1 + Rate/100 }time, which is the basic formula for amount in the
case for compound interest, this is the formula to be used for calculating present value. From here
Pv = Fv / {1 + Rate/100 }time
This is the same formula as of the compound interest, herein we are calculating principal from the amount, which's
it!
Practical applications of the NPv
1. !nstallment schemes
Today there are all kinds of loans and financing of various products right from two wheelers to houses. When a loan
is taken, customer generally pays a monthly installment, his dues reduced by that amount and the interest is charged
only on the balance amount which is known as reducing balance. Also there are many other concepts like floating
rates etc, but they are out of purview of CAT. Here is the monthly installment formula for a fixed rate of interest
(fixed means which does not change over time, floating means which changes with market conditions):
Nonthly !nstallment, N = |A/(1B)] x P
Here A = R/1200 (where R is the rate of interest)
B = |1/(1+A)]T (Where T is time in months)
And P is the principal amount that is the amount of loan taken
The installment can be calculated with this formula by using concept of NPv also. This formula is derived from there
only. You can find this formula in Nicrosoft excel also under PNT in the formula section. But these annuity formula
questions will not be asked in CAT.
Example 10: !f Ram takes a home loan of S00000 for 3 years at the rate of 7.S, what will be his monthly
installment?
T = 12 x 3 = 36 months
R = 7.S
P = S00000
Using the formula, N = |A/(1B)] x P
A = 7.S/1200 = 0.0062S
B = |1/(1+A)]T = |1/(1+0.0062S)]36
N = |0.0062S / {1 |1/(1+0.0062S)]36}] x S00000
N = 1SSS3

$uestion 1
Braun invested a certain sum of money at 8 p.a. simple interest for 'n' years. At the end of 'n' years, Braun got back 4
times his original investment. What is the value of n?
A. S0 years
B. 2S years
C. 12 years 6 months
D. 37 years 6 months
E. 40 years
The correct choice is (D) and the correct answer is 37 years 6 months.
Explanatory Answer
Let us say Braun invested $100.

Then, at the end of 'n' years he would have got back $400.

Therefore, the Simple !nterest earned = 400 100 = $300.

We know that Simple !nterest =

Substituting the values in the above equation we get 300 =

Or 8n = 300

Or n = 37.S years.
$uestion 2
Shawn invested one half of his savings in a bond that paid simple interest for 2 years and received $ SS0 as interest. He
invested the remaining in a bond that paid compound interest, interest being compounded annually, for the same 2 years at
the same rate of interest and received $60S as interest. What was the value of his total savings before investing in these
two bonds?
A. $ SS00
B. $ 11000
C. $ 22000
D. $ 27S0
E. $ 44000
The correct choice is (D) and the correct answer is 27S0.
Explanatory Answer
Shawn received an extra amount of ($60S $SS0) $SS on his compound interest paying bond as the interest that he
received in the first year also earned interest in the second year.

The extra interest earned on the compound interest bond = $ SS

The interest for the first year = $ = $ 27S

Therefore, the rate of interest = = 20 p.a.

20 interest means that Shawn received 20 of the amount he invested in the bonds as interest

!f 20 of his investment in one of the bonds = $27S, then his total investment in each of the bonds = = $ 137S

As he invested equal sums in both the bonds, his total savings before investing = 2*137S = $ 27S0.
$uestion 3
Ann invested a certain sum of money in a bank that paid simple interest. The amount grew to $240 at the end of 2 years.
She waited for another 3 years and got a final amount of $300. What was the principal amount that she invested at the
beginning?
A. $ 200
B. $ 1S0
C. $ 210
D. $ 17S
E. !nsufficient data
The correct choice is (A) and the correct answer is 200.
Explanatory Answer
The sum grew to $240 at the end of 2 years.

At the end of another 3 years, the sum grew to $ 300.

i.e. in 3 years, the sum grew by $ 60.

Therefore, each year, it grew by $ 20.

Sum at the end of 2 years = $ 240

Sum grew by $ 20 each year.

Hence, in the first 2 years, sum grew by 2 * 20 = $ 40.

Therefore, sum at the beginning of the period = Sum at the end of 2 years $40 = $ 240 $ 40 = $ 200.
$uestion 4
Peter invested a certain sum of money in a simple interest bond whose value grew to $300 at the end of 3 years and to $
400 at the end of another S years. What was the rate of interest in which he invested his sum?
A. 12
B. 12.S
C. 6.67
D. 6.2S
E. 8.33
The correct choice is (E) and the correct answer is 8.33.
Explanatory Answer
!nitial amount invested = $ X

Amount at the end of year 3 = $ 300

Amount at the end of year 8 (another S years) = $ 400

Therefore, the interest earned for the S year period between the 3rd year and 8th year = $400 $300 = $100

As the simple interest earned for a period of S years is $ 100, interest earned per year = $20.

Therefore, interest earned for 3 years = 3 * 20 = $ 60.

Hence, initial amount invested X = Amount after 3 years interest for 3 years

= 300 60 = $ 240.

Rate of interest = = = 8.33