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

ones bankers year, which is

1 bankers 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

4)
= Pi for leap year

(Eqn.

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)

Intere
st
Period

Principal at
the
beginning
of the
period

Interest
earned
during
period

Compound amount at
the end of period

P(1 + i)

Pi

P + Pi = P(1 + i)

P(1 + i)2

P(1 + i)i

P(1 + i) + P(1 + i)I = P(1

+ i)2

P(1 + i)3

P(1 + i)2i

P(1 + i)2 + P(1 + i)2i =P(1

+ i)3

COMPOUND
n
P(1 + INTEREST
i)
P(1 + i) i
n

n-1

P(1 + i)n-1 + P(1 + i)n-1i =

P(1 + i)n = F

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
periodsRate
per year.
Effective
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 = F
Present
Value

1 = (1 + i)n 1

Eqn. 10

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