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COMPOUND

INTEREST
LESSON 3
PREPARED BY: ENGR. JELZ D. GENOSAS
CASH FLOW DIAGRAM
CASH FLOW DIAGRAM

RECEIPT (POSITIVE CASH FLOW OR CASH INFLOW

DISBURSEMENT (NEGATIVE CASH FLOW OR CASH OUTFLOW


SAMPLE CASH FLOW

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

P 150

0 1 2 3 4 5

P 100

a) Cash Flow diagram on the viewpoint of the lender


SAMPLE CASH FLOW

P 100

0 1 2 3 4 5

P 150

b) Cash Flow diagram on the viewpoint of the borrower


COMPOUND INTEREST

• The interest earned by the principal which is added to the principal will also earn an interest for the succeeding periods.
𝒓 𝒎𝒕
𝑭 = 𝑷(𝟏 + )
𝒎
𝒓
𝑷 = 𝑭(𝟏 + )−𝒎𝒕
𝒎
where: P – present worth
F – compound amount at the end of “n” periods
i – rate of interest ( ordinary interest divided by m)
m – number of periods per year
(annually m=1; semi-annually m=2; quarterly m=4;
monthly m=12; bi-monthly m=6)
t – number of years
RATE OF INTEREST
• Nominal Interest
The nominal interest specifies the rate of interest and a number of interest periods in
one year.
𝑟
𝑖=
𝑚
where
i = rate of interest per interest period
r = nominal interest rate
m = number of compounding periods per year
NOMINAL INTEREST

• If the nominal interest is 10% compounded quarterly,


then the rate of interest per interest period is

0.10
𝑖= = 0.025 𝑜𝑟 2.5%
4
RATE OF INTEREST

• Effective rate of interest


Effective rate of interest is the actual or exact rate of interest on
the principal during one year.

𝒓 𝒎
𝒊𝒆 = (𝟏 + ) −𝟏
𝒎
EFFECTIVE INTEREST

• If the nominal interest is 10% compounded quarterly,


then the effective interest will be

0.10 4
𝑖𝑒 = (1 + ) −1 = 0.1038 𝑜𝑟 10.38%
4
SAMPLE PROBLEM 1
• Find the nominal rate which is converted quarterly
could be used instead of 12% compounded
monthly. What is the corresponding effective rate?

Ans. 𝒊𝒆 = 𝟏𝟐. 𝟔𝟖%; 𝒓 = 𝟏𝟐. 𝟏𝟐%


SAMPLE PROBLEM 2

• 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.

Ans. P1,226.34
SAMPLE PROBLEM 3

• Find the present worth of a future payment


of P300,000 to be made in 5 years with an
interest rate of 8% per annum

Ans. P204,174.96
SAMPLE PROBLEM 4

• Find the present worth of a future payment of


P100,000 to be made in 10 years with an
interest of 12% compounded quarterly.

Ans. P30,655.68
SAMPLE PROBLEM 5

• In how many years is required for P2,000 to


increase by P3,000 if interest at 12%
compounded semi-annually?

Ans. 7.86 years


SAMPLE PROBLEM 6

• John borrowed P50,000.00 from the bank


at 25% compounded semi-annually. What is
the equivalent effective rate of interest?

Ans. 26.56%
SAMPLE PROBLEM 7
• A sum of P1,000.00 is invested now and left for eight
years, at which time the principal is withdrawn. The
interest has accrued is left for another eight years. If the
effective annual interest rate is 5%, what will be the
withdrawal amount at the end of the 16th year?
Ans. P705.42
SAMPLE PROBLEM 8
• A man bought a lot worth P1,000,000 if paid in cash. On
the installment 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 interest was
20%.

Ans. P792,576
SEATWORK:
1.Compute the equivalent rate of 6% compounded semi-
annually to a rate compounded quarterly.
2.If P5000 shall accumulate for 10 years at 8%
compounded quarterly. Find the compounded interest at
the end of 10 years.
3.P1,500 was deposited in a bank account 20 years ago.
Today it is worth P3,000. Interest is paid semi-annually.
Determine the interest paid on this account?
PROBLEM SET:
1. A merchant puts in his P2000 to a small business for a period of six years. With a
given interest rate on the investment of 15% per year, compounded annually, how
much will he collect at the end of the sixth year?
2. By the condition of a will, the sum of P2000 is left to a girl to be held in trust fund
by her guardian until it amounts to P50,000. When will the girl received the money
if the fund is invested at 8% compounded quarterly?
3. The amount of P12,800 in 4 years at 5% compounded quarterly is?
4. A man expects to receive P25,000 in 8 years. How much is that money worth now
considering interest at 8% compounded quarterly?
5. At an interest rate of 10% compounded annually, how much will a deposit of
P1500 be in 15 years?

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