Business Math Chapter 23

Simple & Compound Interest

Notes

When you borrow money, an additional amount of money is added to

the original amount to borrow this is called Interest.
Simple Interest is used when a loan or investment is repaid in a lump
sum.
Compound Interest most often applies to savings accounts, loans,
installments, and credit cards.

b.
c.
d.
e.

i. Terms Used for Calculating Simple

Interest
Face Value or Principal (P) the amount borrowed or invested for
a certain period of time.
Interest (I) is the amount paid only on the principal for the
privilege of using someones money or earned on investment
money.
Rate (R) charged or earned in one year, is expressed as a
percent of the amount borrowed or earned.
Time (T) the length of time you have to repay the loan or earn
interest on your invested money.

f. Calculating Simple Interest

g. I = P x R x T
i. Example: Suppose Brittany wants to borrow $900 for one
year at 12% interest:
I=PxRxT
I = $900 x 0.12 x 1
I = $108
ii. Example: Suppose Shea was borrowing $900 for 8 months
at 12% interest.
I=PxRxT
I = $900 x 0.12 x 8/12
I = $72
h. Finding the Maturity Value of a Loan
i. Maturity value (M) is the full amount of money that must be
repaid when a loan is due.
j. M = P + I
i. Example: Suppose Amy is borrowing $1,825 at 12%
interest for 1 year. What is the maturity value?
I=PxRxT
I = $1,825 x 0.12 x 1
I = $219

k.

M=P+I
M = $1,825 + $219
M = $2,044
Finding Ordinary and Exact Interest
l. Ordinary Interest
i. 360 days (12 months of 30 days each)
ii. Example: Loan of $4,000 at 9% for 60 days
I=PxRxT
I = $4,000 x 0.09 x 60/360
I = $60
m. Exact Interest
i. 365 days (366 days in a leap year)
ii. Example: Loan of $4,000 at 9% for 60 days
I=PxRxT
I = $4,000 x 0.09 x 60/365
I = $59.18

V. Finding the Due Date

a.
It is common to find the date of a loan due at 90 days. When
this occurs you need to count the actual number of days to
determine the date of maturity.
i.
Example: Loan date is April 15; loan is due in 120
days. What is the due date?
Step One determine number of days
a. April (30 days: 30-15=15 days remaining)
b. May (31 days)
c. June (30 days)
d. July (31 days)
Step Two add the days counted
15+31+30+31=107
Step Three Subtract those days from the 120 days due.
120-107=13 days
a. August has 13 days to be counted for this time
period.
b. The maturity date would be August 13.

Number of Days in Each Month

28 Days
February
(29 in a leap year)

30 Days
April
June
September
November

31 Days
January
March
May
July
August
October
December

VI. Finding Principal, Rate, or Time When Interest is Known

a. Finding Principal
i.
P = I/R x T
ii.
Example: Suppose Liz wants to determine the amount of
principal it will take to earn $170 interest in 120 days at
12%. (360 Day method)
P = I/R x T
P = $170/0.12 x 120/360
P = $4,250
b. Finding the Rate
i.
R = I/P x T
ii.
Example: Suppose Krystal borrows $1,200 for 90 days and
the interest is $35. What is the interest rate?
R = I/P x T
R = $35/$1,200 x 90/360
R = 11.7%
c. Finding the Time
i.
T (in years) = I/P x R
ii.
Example: Tracis loan is $795 at 12% and the interest is
$110. What is the amount of time for this loan?
T = I/P x R
T = $110/$795 x 0.12
T = $110/95.40
T = 1.15 years
1.15 years x 360 days = 414 days
VII. Promissory Notes
a.
b.

c.
d.
e.
f.

When you borrow money from a business or bank, you sign a

document, usually called a promissory note.
The signer agrees:
i. To pay a specific amount of money
ii. By a specific date
iii. To a specific individual or business
If the promissory note states the interest rate then it is called
an interest-bearing note
If the note doesnt specify an interest rate then it is called a
non-interest-bearing note.
The interest is collected in advance and is called a bank
discount.
The amount the borrower receives (maturity value the bank
discount) is called the proceeds.

VIII. Discounting a Note

a. Discounting commercial paper the bank discounts the note and
charges a fee based on the maturity value of the note.
b. Discount date the date the bank discounts the note.
c. Discount the dollar amount of the bank discount.
d. Formula used for finding the bank discount
i. B (bank discount) = M (maturity value) x DR (discount rate)
x T (term)
ii. Example: Tanya has signed a promissory note for $4,000 at
12%, due 4 months, payable to Mr. Palmer. The bank
discounts the note for Mr. Palmer 16%, two months before
maturity of the note.
Step One Calculate the Interest
I=PxRxT
I = $4,000 x 12% x 4/12
I = $160.00
Step Two Calculate the maturity value
M=P+I
M = $4,000 + $160.00
M = $4,160.00
Step Three Calculate the bank discount
B = M x DR x T
B = $4,160 x 0.16 x 60/360
B = $110.93
Step Four Calculate the proceeds
P=MB
P = $4,160 - $110.93
P = $4,049.07
VIIII. Compound Interest
a. Compounding interest when interest on a loan or investment is
calculated more than once during the time period, this interest is
added to the principal and then becomes the principal for the next
calculation of interest.
b. Terms Used For Compounding Interest
i. Compound Interest interest calculated on reinvested
interest as well as on the original principal.
ii. Compound Amount the sum of the original principal and
its compound interest.

iii. Interest Period the time (daily, monthly, quarterly,

semiannually, or annually) for which interest has been
computed.
iv. Present Value a future compound amount is the principal
invested at a given rate today that will grow to the
compound amount at a later date.
1. Example: Michelle wants to find out what the
compound interest would be on the original principal
of $2,200 at 12% compounded annually for 2 years.
Step One Find Interest
I=PxRxT
I = 2,200 x 0.12 (first year) x 1
I = $264 (end of first year)
Step Two Add Principal and Interest
$2,200 + $264 = $2,464
Step Three Compound Interest for next year
I = 2,464 x 0.12 (second year)
I = $295.68
Step Four Add Compound and Principal
$2,464 + $295.68 = $2,759.68
Step Five Subtract Original Principal from
Compound Amount to find Compound Interest
I = 2,759.68 2,200
I = $559.68
c. Compounding Interest Semiannually or Quarterly
i. Example: Principal - $5,000
Interest Rate 10% (10/2 = 5)
Time 2 years
Compounded Semiannually
Original amount
$5,000.00
Interest 1st Compound
+ 250.00
$5,250.00
Interest 2nd Compound
+ 262.50
$5,512.50
Interest 3rd Compound
+ 275.63
$5,788.13
Interest 4th Compound
+ 289.41
Compound Amount $6,077.54
Original Principal
-5,000.00
Compound Interest $1,077.54
ii. Example: Principal - $500
Interest Rate 8% (8/4 = 2)
Time 1 year
Compounded Quarterly
Original amount

$500.00

(5,000 x 0.05)
(5,250 x 0.05)
(5,512.50 x 0.05)
(5,788.13 x 0.05)

Interest 1st Compound + 10.00 (500 x 0.02)

510.00
nd
Interest 2 Compound
+ 10.20 (510 x 0.02)
520.20
Interest 3rd Compound + 10.40 (520.20 x 0.02)
530.60
th
Interest 4 Compound + 10.61 (530.60 x 0.02)
Compound amount
541.21
Principal
- 500.00
Compound Interest
41.21
d. Calculating Interest Using Compound Interest Table
i. Example:
Original Principal - $2,500
Interest Rate 6% annually
Time 2 years
e. Calculating Present Value Using a Present Value Table
i. Example:
Future Amount - $10,000
Interest Rate 8% (quarterly)
Time 3 years

f. Present Value Compounded Quarterly

i.
Example: Liz is planning to attend community
college in 2 years. She expects this to cost $7,000.
Calculate how much money she needs to invest
today at 12% compounded quarterly to have $7,000
in 2 years.