CHAPTER II

INTEREST AND MONEY-TIME RELATIONSHIPS

INTEREST
- the amount of money paid for the use of
borrowed capital or the income produced by the
money which has been loaned
SIMPLE INTEREST
- calculated using the principal only, ignoring any
interest that have been accrued in preceding
periods

- paid on a short-term loans in which the time of

the loan is measured in day

I  Pni where:
I= interest
P=principal or present worth
n=number of interest period

F  P (1  ni ) i= rate of interest per interest period

F= accumulated amount or future worth
Determine the exact simple interest on P500 for the period
from Jan. 10 to Oct. 28,1996 at 16% interest.
Solution:
Jan – 21

I = Pni
Feb – 29

Mar – 31

Apr – 30 = P500(292/366)(0.16)
May – 31 = P63.83
Jun – 30
Ans
Jul – 31

Aug – 31

Sep – 30

Oct – 28

TOTAL: 292 days

SAMPLE PROBLEM
a. Ordinary Simple Interest –computed on the basis of 12 months
of 30 days a year

1 interest period= 360 days

b. Exact Simple Interest –based on the exact number of

days in a year, 365 days for an ordinary year and 366
days for a leap year

1 interest period= 365 or 366 days

SIMPLE INTEREST
Determine the ordinary simple interest on P700 for 8
months and 15 days if the rate of interest is 15%.

Solution:

n= (8)(30)+15= 255 days

I = Pni =P700(255/360)(0.15) = P74.38 Ans

SAMPLE PROBLEM
Cash Flow Diagram
- simply a graphical representation of cash flows
drawn on a time scale

Receipt (positive cash flow or cash inflow)

Disbursement (negative cash flow or cash outflow)

A loan of P100 at simple interest of 10% will
become P150 after 5 years.
150

0 1 2 3 4 5

100
Cash flow diagram on the viewpoint of the lender

100

0 1 2 3 4 5

150
Cash flow diagram on the viewpoint of the borrower

Cash Flow Diagram

COMPOUND INTEREST
- In calculations of compound interest, the interest
for an interest period is calculated on the principal
plus total amount of interest accumulated in
previous periods.
- means “interest on top of interest”
COMPOUNDING FREQUENCIES AND PERIODS
FREQUENCY NO. PER YEAR PERIOD
Annually 1 1year
Semi-annually 2 6months
Quarterly 4 3months
Monthly 12 1month
Daily 365 1day
Interest Principal at Interest Amount at End of
Period the Earned Period
Beginning of During Period
Period

1 P Pi P+Pi=P(1+ni)

2 P(1+i) Pi(1+i) P(1+i)+Pi(1+i)

= P(1+i)^2

3 P(1+i)^2 Pi(1+i)^2 P(1+i)^2+Pi(1+i)^2

=P(1+i)^3
... ... ... ...

n P(1+i)^(n-1) Pi(1+i)^(n-1) P(1+i)^n

COMPOUND INTEREST
- The quantity is commonly called the “single payment
compound amount factor” and is designated by functional
symbol F/P, i%, n.
- this symbol is read as “F given P at i
per cent in n interest periods”

- The quantity is commonly called the “single payment

present worth factor” and is designated by functional symbol
P/F, i%, n.
- this symbol is read as “P given F at i
per cent in n interest periods”

COMPOUND INTEREST
Rate of Interest
a. Nominal rate of interest - specifies the rate of
interest and a number of interest periods in one
year
where:
i=rate of interest per interest period
r=nominal interest rate
m=number of compounding periods per year

b. Effective rate of interest – the actual or exact rate

of interest on the principal during 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 (i.e. Quarterly, monthly, etc.)

COMPOUND INTEREST
Find the nominal rate if converted quarterly could
be used instead of 12% compounded monthly.
What is the corresponding effective rate?

ANSWER: 12.12% compounded quarterly

SAMPLE PROBLEM
A P2000 loan was originally made at 8% simple
interest for 4 years. At the end of this period the
loan was extended for 3 years, without the
interest being paid, but the new interest rate was
made 10% compounded semi—annually. How
much should the borrower pay at the end of 7
years?

ANSWER: P3,537.86

SAMPLE PROBLEM
Find the amount at the end of two years and seven
months if P1000 is invested at 8% compounded
quarterly using simple interest for anytime less
than a year interest period.

ANSWER: P1,226.834

SAMPLE PROBLEM
EQUATION OF VALUE
- is obtained by setting the sum of the values on a
certain comparison or focal date of one set of
obligations equal to the sum of the values on the
same date of another set of obligations
A man bought a lot worth P1,000,000 if paid in cash.
On the instalment basis, he paid a down payment of
P200,000; P300,000 at the end of one year;
P400,000 at the end of three years and a final
payment at the end of five years. What was the final
payment if the interest was 20%?

ANSWER: P792,576

SAMPLE PROBLEM
Over the past 10 years, Gentrack has placed
varying sums of money into a special capital
accumulation fund. The company sells compost
produced by garbage-to-compost plants in
the United States & Vietnam. At the start, $1000
was placed, $3000 at the 4th year and $1500 on its
6th year. Find the amount in the account now (after
10 years) at an interest rate of 12% per year,
compounded semiannually using [a] semiannual
CP and [b] effective annual rate.

ANSWER: $11,634

SAMPLE PROBLEM
CONTINUOUS COMPOUNDING AND DISCRETE PAYMENTS

- In discrete compounding, the interest is

compounded at the end of each finite- length period,
such as a month, a quarter or a year
- In continuous compounding, it is assumed that cash
payments occur once a year, but the compounding is
continuous throughout the year
Compare the accumulated amounts after 5
years of PhP1,000 invested at the rate of
10% per year compounded
a. Annually
b. Semi-annually
c. Quarterly
d. Monthly
e. Continuously

ANSWER: a. P1,610.51, b. P1,628.89, c. P1,638.62,

d. P1,645.31, e. P1, 648.72

Sample Problem
DISCOUNT
-the difference between the present worth and the
worth at some time in the future
-interest paid in advance

• Rate of discount – the discount on one unit of principal for

one unit of time

where: d= rate of discount for the period involved

i= rate of interest for the same period
A man borrowed P5000 from a bank and agreed to
pay the loan at the end of 9 months. The ban
discounted the loan and gave him P4000 in cash.
a)What was the rate of discount?
b)What was the rate of interest?
c)What was the rate of interest for one year?

ANSWER: a. 20%, b. 25%, c. 33.33%

SAMPLE PROBLEM
INFLATION
- the increase in the prices for goods and services
from one year to another , thus decreasing the
purchasing power of money

where: PC= present cost of the commodity

FC= future cost of the same commodity
f= annual inflation rate
n= number of years
-In an inflationary economy, the buying power of
money decreases as cost increases.

where: P= present worth

F= future worth
f= annual inflation rate
n= number of years

-If interest is being compounded at the same time

that inflation is occurring, the future worth will be

INFLATION
An economy is experiencing inflation at an annual
rate of 8%. If this continues, what will P1000 be
worth two years from now in terms of today’s pesos?

ANSWER: P857.34

SAMPLE PROBLEM
A man invested P10000 at an interest rate of 10%
compounded annually. What will be the final amount
of his investment, in terms of today’s pesos, after
five years, if inflation remains the same at the rate
of 8% per year?

ANSWER: P10,960.86

SAMPLE PROBLEM
ANNUITIES
- a series of equal payments occurring at equal
periods of time.

- annuities occur in the following instances:

- payment of a debt by a series of equal payments
at equal intervals of time.
- accumulation of a certain amount by setting
equal amounts periodically.
- substitution of a series of equal amounts
periodically in lieu of a lump sum at retirement of
an individual.
-
ANNUITIES
- a series of equal payments occurring at equal
periods of time
-

• Ordinary Annuity - one where the payments is made at the

end of each period

where: P= value or sum of money at present

F= value or sum of money at some future time
A= a series of periodic, equal amounts of money
n= number of interest period
i= interest rate per interest period
• Finding P when A is given
P

0 1 2 3 n-1 n

A A A A A

A(P/F,i%,1)

A(P/F,i%,2)

A(P/F,i%,3)

A(P/F,i%,n-1)

A(P/F,i%,n)

Cash flow diagram to find P given A

ANNUITIES
• Finding F when A is given

0 1 2 3 n-1 n

A A A A A

A(F/P,i%,1)

A(F/P,i%,n-3)

A(F/P,i%,n-2)

A(F/P,i%,n-1)

Cash flow diagram to find F given A

ANNUITIES
- The quantity is called the “uniform series present
worth factor” and designated by the functional symbol P/A, i
%, n.

- The quantity is commonly called the “uniform series

compound amount factor” and designated by the functional
symbol F/A, i%, n.

- The quantity is commonly called the “capital recovery

factor” and denoted by the functional symbol A/P, i%, n.

- The quantity is commonly called the “sinking fund

factor” and denoted by the functional symbol A/F, i%, n.

ANNUITIES
What are the present worth and the accumulated
amount of a 10-year annuity paying P10,000 at the
end of each year, with interest at 15% compounded
annually?

ANSWER: P = P50,188,
F = P203,037

SAMPLE PROBLEM
What is the present worth of P500 deposited at the
end at every 3 months for 6 years if the interest rate
is 12% compounded semi-annually?

ANSWER: P8,504

SAMPLE PROBLEM
DEFERRED ANNUITY
• Deferred Annuity – one where the payment of the first
amount is deferred a certain number of periods after the
first.
If P10,000 is deposited each year for nine years,
how much annuity can a person get annually from
the bank every year for 8 years starting one year
after the 9th deposit is made. Cost of money is 14%.

ANSWER: A = 34,675

SAMPLE PROBLEM
A debt of P40000 , whose interest rate is 15%
compounded semi-annually, is to be discharge by a
series of 10 semi-annual payments, the first
payment to be made six months after consummation
of the loan. The first 6 payments will be P6000 each,
while the other four payments will be equal and of
such amount that the final payment will liquidate the
debt. What is the amount of the last 4 payments?

ANSWER: P5,454

SAMPLE PROBLEM
ANNUITY DUE
- one where the payments are made at the
beginning of each period

P • Finding P when A is given

0 1 2 3 n-1 n

A A A A A
 • Finding F when A is given
F

0 1 2 3 n-1 n

A A A A A

ANNUITY DUE
 A certain property is being sold and the owner
received two bids.
The first bidder offered to pay P400000each year
for five years, each payment is to be made at the
beginning of each year. The second bidder offered to
pay P240000 first year, P360000 the second year
and P540000 each year for the next three years, all
payments will be made at the beginning of each
year.
If money is worth 20% compounded annually,
which bid should the owner of the property accept?

SAMPLE PROBLEM
PERPETUITY
- an annuity in which the payments continue
indefinitely

P • Finding P when A is given

0 1 2 3 n

A A A A
 What amount of money invested today at 115%
interest can provide the following scholarship:
P30000 at the end of each year for six years;
P40000 for the next six years ad P50000 thereafter.

SAMPLE PROBLEM
CAPITAL COST

- one of the most important application of perpetuity

- the sum of the first cost and the present worth of

all costs of replacement, operation and maintenance
for a long time or forever

PERPETUITY
AMORTIZATION
- Any method of repaying a debt, the principal and
interest included, usually by a series of equal
payments at equal interval of time
 A debt of P5000 with interest AT 12%
compounded semi-annually is to be amortized by
equal semi-annual payments over the next 3 years,
the first due in 6 months. Find the semi-annual
payment and construct an amortization schedule.

SAMPLE PROBLEM
Uniform Arithmetic Gradient
- In a certain cases, economic analysis problems
involve receipts or disbursements that increase or
decrease by a uniform amount each period. This is
known as the uniform arithmetic gradient.

(n-1)(G)
3G
2G
A A A A A 1G

0 1 2 3 4 5 0 1 2 3 4 5

P
P
A loan was amortized by a group of four end-of-
year payments forming an ascending arithmetic
progression. The initial payment was to be P5000
and the difference between successive payments
was to be P400. But the loan was renegotiated to
provide for the payment of equal rather than
uniformly varying sums. If the interest the of the
loan was 15%, what was the annual payment?

SAMPLE PROBLEM
END OF CHAPTER 2
THANK YOU AND GOD BLESS YOU 