Chp8 3edition PDF
Chp8 3edition PDF
Chp8 3edition PDF
Interest
UNIT OBJECTIVES
Unit 8.1 Computing simple interest and Unit 8.2 Solving for principal, rate, and time
maturity value
a Solving for P (principal) and T (time)
a Computing simple interest and maturity value
b Solving for R (rate)
loans stated in months or years
b Counting days and determining maturity date Unit 8.3 Compound interest
loans stated in days
c Computing simple interestloans stated in days
a Understanding how compound interest differs from
simple interest
b Computing compound interest for different com-
pounding periods
151
Unit 8.1 Computing simple interest and maturity value
Wendy Chapman just graduated from college with
a degree in accounting and decided to open her
own accounting office (she can finally start earning
money instead of paying it on college). On July 10,
2005, Wendy borrowed $12,000 from her Aunt
Nelda for office furniture and other start-up costs.
She agreed to repay Aunt Nelda in 1 year, together
with interest at 9%.
The original amount Wendy borrowed
$12,000is the principal. The percent that
Wendy pays for the use of the money9%is the
rate of interest (or simply the interest rate). The
length of time1 yearis called the time or
term. The date on which the loan is to be repaid
Banks provide a valuable service as money bro-
July 10, 2006is called the due date or maturity kers. They borrow from some people (through
date. The total amount Wendy must repay (which savings accounts, etc.) and loan that same
we will calculate later) consists of principal money to others (at a higher rate). Some of
($12,000) and interest ($1,080); the total amount these loans are simple interest loans.
($13,080) is called the maturity value.
= s i m p l e i n t e re s t f o r m u l a
I = PRT
I = Dollar amount of interest P = Principal R = Annual rate of interest T = Time (in years)
Example 1 On July 10, 2005, Wendy Chapman borrowed $12,000 from her Aunt Nelda. If Wendy agreed to
pay a 9% annual rate of interest, calculate the dollar amount of interest she must pay if the loan is
for (a) 1 year, (b) 5 months, and (c) 15 months.
____________
Key s t ro ke s ( f o r m o s t c a l c u l a t o r s )
12,000 9 % = 1,080.00
12,000 9 % 5 12 = 450.00
12,000 9 % 15 12 = 1,350.00
M=P+I
M = Maturity value P = Principal I = Dollar amount of interest
Example 2 Refer to Example 1. Calculate the maturity value if the 9% $12,000 loan is for (a) 1 year, (b) 5
months, and (c) 15 months.
____________
a. 1 year: M = P + I = $12,000 + $1,080 = $13,080
b. 5 months: M = P + I = $12,000 + $450 = $12,450
c. 15 months: M = P + I = $12,000 + $1,350 = $13,350
Wendy must pay a total of $13,080 if the loan is repaid in 1 year (July 10, 2006), $12,450 if the loan
is repaid in 5 months (December 10, 2005), and $13,350 if the loan is repaid in 15 months (October
10, 2006).
Example 3 Find (a) 90 days from September 10, 2006; (b) 180 days from September 10, 2006; and (c) 180
days from September 10, 2007.
____________
a. Sep. 10 Day 253
+90
Dec. 9 343
In parts (b) and (c) of Example 3, we found that the final date was the 68th day of the year. For
a non-leap year, the 68th day is March 9. With a leap year, like 2008, there is an extra day in February
so March 9 is day 69; March 8 is day number 68.
An optional method for counting days is known as the days-in-a-month method. With this
method, we remember how many days there are in each month; the method is shown in Appendix
D, page D-2. While a day-of-the-year calendar is often easier to use, understanding the days-in-a-
month method is important because we may not always have a day-of-the-year calendar with us.
Here is how we could do Example 3, part (c), using the days-in-a-month method:
In the next example, well figure out how many days between two dates. For some of us, there
are quite a few days between dates (oops, wrong kind of date).
Example 4 Find the number of days between each set of dates: (a) July 24 to November 22, (b) July 24 to March
13 of the following year (non-leap year), and (c) July 24 to March 13 (leap year).
____________
a. Nov. 22 Day 326 (Last day is minuend, on top)
July 24 Day -205
121 days
b. Number of days left in first year: 365 - 205 (day number for July 24) 160
Number of days in next year: Mar. 13 +72
232 days
c. Number of days left in first year: 365 - 205 (day number for July 24) 160
Number of days in next year: Mar. 13 72 + 1 (for leap year) +73
233 days
In part (b) of Example 4 (non-leap year), March 13 is day 72. But with a leap year in part (c),
there is an extra day in February, making March 13 day 73, not day 72.
Here is how we could do Example 4, part (c), using the days-in-a-month method:
The Truth in Lending Act, also known as Regulation Z, applies to consumer loans. The regulation
does not set maximum interest rates; however many states set limits. It does require lenders to notify
the borrower of two things: how much extra money the borrower is paying (known as finance
charges) as a result of borrowing the money and the annual percentage rate (APR) the borrower is
paying, accurate to 18 of 1%. The law does not apply to business loans, loans over $25,000 (unless
they are secured by real estate), most public utility fees, and student loan programs. Apparently, the
government figures that businesspeople andget thisstudents are bright enough to figure their
own APR.
Prior to 1969, when the Truth in Lending Act became effective, lenders generally used a 360-
day year for calculating interest. Without calculators and computers, calculations were easier using a
360-day year than a 365-day year. In calculating an APR for Truth in Lending purposes, lenders are
required to use a 365-day year. Many lenders use a 360-day year for business loans (remember, busi-
ness loans are exempt from the Truth in Lending Act).
Although we will not emphasize the following terminology, some people and some textbooks
refer to interest based on a 360-day year as ordinary interest (or bankers interest) and interest
based on a 365-day year as exact interest.
Example 5 Calculate interest on a 90-day $5,000 loan at 11%, using (a) a 360-day year and (b) a 365-day year.
____________
a. 90 = $137.50
360-day year: I = PRT = $5,000 11% 360
90
b. 365-day year: I = PRT = $5,000 11% 365 = $135.62
As you can see from Example 5, a 360-day year benefits the lender and a 365-day year benefits
the borrower.
While some loan agreements require the borrower to pay a prepayment penalty if the loan is paid
off early, most loans give the borrower the right to prepay part or all of the loan without penalty. Most
lenders rely on what is called the U.S. Rule to calculate interest. With the U.S. Rule, interest is cal-
culated to the date payment is received and on the basis of a 365-day year.
Example 6 Refer to Example 5, in which you get a 90-day $5,000 loan at 11%. You are able to pay the loan off
early, in 65 days. Calculate interest using the U.S. Rule.
____________
65 = $97.95
I = PRT = $5,000 11% 365
Interest is $97.95. You saved $37.67 ($135.62 - $97.95) by paying off the loan early.
p a r t i a l p ay m e n t s : c a l c u l a t i n g i n t e re s t ,
p r i n c i p a l , a n d re m a i n i n g b a l a n c e
Step 1 Calculate interest: I = PRT
Step 2 The remainder of the payment is principal: Principal = Total paid - Interest portion
Step 3 New balance = Previous balance - Principal portion of payment
Note: For the final payment, principal is the previous balance (so the balance will end up zero).
Example 7 Refer to Example 6, in which you get a 90-day $5,000 loan at 11% interest. Suppose you have some
extra cash and pay $2,000 on day 21 (21 days after getting the loan); on day 65 (65 days after get-
ting the loan) you pay off the loan. Calculate the amount of interest and principal for each payment
as well as the total amount of your final payment.
____________
Notice that in Example 7 you paid total interest of $71.84 compared to interest of $97.95 in Example
6. You may wonder why you saved some interest since both loans were paid off on day 65. The rea-
son is that by paying $2,000 on day 21, the balance decreased, and interest for the last 44 days was
figured on that reduced balance.
Well, that does it for this unit. Lets do the U-Try-It exercises to see if you understand the prin-
cipal points of this unit. Take your time; do the problems at your own rate.
1. Suppose you borrow $8,000 for 18 months at 11% simple interest. Find: (a) interest and
U-Try-It (b) maturity value.
(Unit 8.1) 2. Find 180 days from August 5.
3. How many days are there between May 22 and October 14?
4. You get a 90-day $15,000 business loan from your bank at 9.25% interest. Calculate interest
assuming the bank uses (a) a 365-day year and (b) a 360-day year.
As a memory aid, some people like to place the symbols I, P, R, and T in a circle (notice that the I
is alone at the top). The formula for each of the variables is found by covering the appropriate
letter. Covering P with your finger, for example, shows I over RT.
I = PRT
I
I
P = RT I
R = PT I
T = PR
P R T
I = Dollar amount of interest P = Principal
R = Annual rate of interest T = Time (in years)
Now we will solve a few problems for the variables P, R, and T. Because there are many more appli-
cations in solving for R than for P and T, we will solve for R last.
Example 1 You open a checking account. You are paid 3% interest on the average balance but are charged a $5
monthly charge. Assuming that interest is paid monthly (regardless of the number of days in the
month), calculate the average balance you must maintain to offset the $5 monthly charge.
____________
I P= I = $5 = $5 = $5 = $2,000
($5) RT 3% 1 .03 1 12 .0025
12
P R T
(?) (3%) (121 ) 1 = $5.00
Check answer: I = PRT = $2000 3% 12
I
($82.19)
T = I = $82.19 = $82.19 = .205475
P R T PR $5,000 8% $400.00
($5,000) (8%) (?)
You are being charged for .205475 of a year. Because there are 365 days in a year:
75
365 days .205475 = 75 days. Check answer: I = PRT = $5,000 8% 365 = $82.19
You are being charged interest for 75 days.
Example 3 You borrow $500 from your uncle and agree to repay the $500 plus $20 interest in 6 months.
What interest rate are you paying?
____________
I
($20)
R = I = $20
6
= $20 = .08 = 8%
P R T PT $500 12 $250
($500) (?) (126 )
Example 4 You get a 90-day $3,000 consumer loan at 8%. You are required to pay a document preparation fee
of $50. Calculate your APR. Express the rate with two decimal places.
____________
Principal (P) for APR purposes is the amount of money you have use of: $3,000 - $50 fee = $2,950
Interest (I) for APR purposes is total finance charges:
90
I = PRT = $3,000 8% 365 = $ 59.18
Document preparation fee + 50.00
Total finance charges $109.18
You are really paying an annual rate (APR) of 15.01%, considerably higher than the 8% stated rate.
Because the loan is a consumer loan, the lender must inform you in writing what the APR is before
you sign the loan agreement.
Suppose, instead of getting the loan in Example 4, you can get a 12% loan with no fees. You
would be better off getting the 12% loan, since the APR is only 12%, while the APR for the loan in
Example 4 is 15.01%.
Some lenders use a 360-day year for business loans. In the next example, we will calculate an
APR on a loan using a 360-day year.
R= I = $33.33
60
= $33.33 ~~ .1014 ~
~ 10.14%
PT $2,000 365 $328.77
Even if interest is calculated using a 360-day year, an APR always uses a 365-day year
You must pay $33.33 interest. You are really paying an annual rate (APR) of 10.14%. Because the loan
is a business loan (not a consumer loan), the lender is not required to inform you of the APR. But
thats no problem because you can calculate your own APR (right?).
Another way to calculate interest is known as the discount method (also referred to as the bank
discount method). This method, not used as much now as in the past, figures interest on the matu-
rity value; the proceeds (maturity value minus interest) are given to the borrower, who must repay
the maturity value. The bank discount method uses a 360-day year.
D = MRT
Proceeds = M - D
D = Bank discount (dollar amount of interest) R = Annual rate
M = Maturity value T = Time, in years (using a 360-day year)
Example 6 You get a loan using the discount method. You sign a note, agreeing to repay the lender $5,000 in 90
days. Assuming a discount rate of 12%, calculate (a) interest (discount), (b) proceeds you receive,
and (c) the APR.
____________
90 = $150
a. D = MRT = $5,000 12% 360
c. APR: R = I = $150
90
= $150 ~ ~ .1254 ~
~ 12.54%
PT $4,850 365 $1,195.89
You will be given $4,850 and must pay back $5,000 in 90 days, resulting in an APR of 12.54%.
In Example 6, the APR (12.54%) is higher than the discount rate (12%). This is due to two fac-
tors: (1) interest for the loan of Example 6 is calculated on the maturity value ($5,000), rather than
the amount you have use of ($4,850), and (2) the discount method uses a 360-day year, whereas the
APR always uses a 365-day year.
That does it for this unit. Lets try the U-Try-It set to find out if it sunk in!
1. You pay your bank $157.50 interest for 6 months on a 9% loan. How much did you borrow?
U-Try-It 2. You pay your bank $78.90 interest on an 8% $4,000 loan. If the bank uses a 365-day year, for
(Unit 8.2) how many days are you being charged interest?
3. You get a $5,000 business loan for 180 days at 10.5% interest. The lender charges you a $150
document preparation fee and uses a 360-day year for calculating interest. What is your APR, to
the nearest hundredth of a percent?
____________
Answers: (If you have a different answer, check the solution in Appendix A.)
1. $3,500 2. 90 days 3. 17.25%
Example 1 Trish and Hannah each have $100. Trish loans her $100 to a friend. Her friend agrees to repay her
in 3 years, together with 6% simple interest. Hannah deposits her $100 in a savings account and
leaves it there for 3 years to accumulate interest at 6%, compounded annually. Calculate the amount
Trish and Hannah will have in 3 years.
____________
Trish will end up with $118. Hannah will end up with $119.10. In figuring interest for Hannah, the
year 1 ending balance ($106) was used to calculate interest for year 2, and the year 2 ending balance
($112.36) was used to calculate interest for year 3. This is how compound interest works; interest is
earned on principal plus previous interest.
In Example 1, because of compounding, Hannah ends up with $1.10 more than Trish. The
amount may seem fairly insignificant. However, as the time period is extended, the difference becomes
substantial. Illustration 8-1 compares simple interest with compound interest over a 100-year period,
using a $100 amount at 10% interest. As you can see, compounding makes quite a difference
($1,378,061.23 balance instead of $1,100). Notice that the balance using simple interest is repre-
sented by a straight line, while the balance using compound interest is represented by an accelerated
curve (due to earning interest on interest).
($1,378,061.23)
How $100 will grow
at 10% interest
($1,100)
Example 2 Hannah deposits $100 in a savings account earning 6% compounded semiannually. What will her
balance be in 6 months?
____________
Lets use the simple interest formula: I = PRT. Remember, T is 6 months, or 12 of a year.
I = PRT = $100 6% 12 = $3 M = P + I = $100 + $3 = $103
In 6 months Hannahs balance will be $103.
Example 3 Find the periodic rate for (a) 6% compounded semiannually, (b) 7.5% compounded quarterly, and
(c) 8.25% compounded monthly.
____________
a. 62 = 3(%) b. 7.5 8.25
4 = 1.875(%) c. 12 = 0.6875(%)
For an interest rate of 6% compounded semiannually, a person will earn 3% each period (6 months);
for 7.5% compounded quarterly, a person will earn 1.875% each period (3 months); and for 8.25%
compounded monthly, a person will earn 0.6875% each period (1 month).
Dont make the common mistake of rounding a preiodic rate. In Example 3(c), the periodic rate for
8.25% compounded monthly is 0.6875%, not 0.69%. In some cases the periodic rate may be a
repeating decimal. For example, the periodic rate for 7% compounded monthly is 0.583 (with the
3s continuing forever). If the periodic rate is used in calculations, be sure to use as many decimal
places for the rate as your calculator will allow (such as 0.58333333%).
In the next example, we will use a periodic rate to find an ending balance. As you will see, it is eas-
ier than using the simple interest formula.
Example 4 Hannah deposits $100 in a savings account earning 6% compounded semiannually and leaves it
there for 3 years. Find the ending balance using the periodic rate of 3%.
____________
Interest Balance
Beginning $100.00
6 months $100.00 3% = $3.00 $103.00
12 months $103.00 3% = $3.09 $106.09
18 months $106.09 3% = $3.18 $109.27
24 months $109.27 3% = $3.28 $112.55
30 months $112.55 3% = $3.38 $115.93
36 months $115.93 3% = $3.48 $119.41
Notice, the dollar amount of interest increases each period as the balance increases. Thats
because of compounding.
Key s t ro ke s ( f o r m o s t c a l c u l a t o r s )
100 + 3 % = 103.00
+ 3 % = 106.09
+ 3 % = 109.27
+ 3 % = 112.55
+ 3 % = 115.93
+ 3 % = 119.41
As you can see, the more often interest is calculated, the more benefit there is to the person receiv-
ing the interest.
That finishes this chapter. Congratulations! As mentioned, the concepts of this chapter are
important to many upcoming topics; we will calculate simple interest and use compounding many
times. Hopefully, that excites you. Now, lets make sure weve got the concepts of this last unit mas-
tered by doing the U-Try-It problems.
1. David Christopher deposits $500 in a savings account earning 5% compounded annually. What
U-Try-It will the balance be in 4 years?
(Unit 8.3) 2. John Travis deposits $1,200 in a savings account earning 4.5% compounded quarterly. What
will the balance be in 1 year?
____________
Answers: (If you have a different answer, check the solution in Appendix A.)
1. $607.75 2. $1,254.92
Chapter in a Nutshell
Obje ctives Examples
U n i t 8 . 1 C o m p u t i n g s i m p l e i n t e re s t a n d m a t u r i t y v a l u e
a Computing simple $5,000 at 8% for 18 months:
interest and matu- 18
I = PRT = $5,000 8% 12 = $600
rity valueloans
stated in months M = P + I = $5,000 + $600 = $5,600
or years
b Counting days and 180 days from Apr. 23: 90 days from Nov. 17:
determining matu-
Apr. 23 Day 113 Nov. 17 Day 321
rity dateloans
+180 + 90
stated in days
Feb. 15 46
Days between Mar. 12 and Oct. 28: Days between Nov. 13 and Apr. 22 (leap year):
Oct. 28 Day 301 First Year: 365 - 317 48
c Computing simple $8,000 at 9% for 90 days, using: (a) 365-day year and (b) 360-day year
interestloans a. I = PRT = $8,000 9% 365 90 = $177.53
stated in days 90 = $180.00
b. I = PRT = $8,000 9% 360
$10,000 at 7% for 180 days; $4,800 partial payment on day 52; balance paid on day 115
b Solving for R (rate) $6,500 business loan for 90 days at 13% interest with $250 set-up fee. If lender uses a 360-day year
to calculate interest, what is APR?
Principal for APR purposes: $6,500 - $250 = $6,250
Interest for APR purposes:
90 = $211.25
I = PRT = $6,500 13% 360
Set-up fee +250.00
Total finance charges $461.25
b (continued) Loan using the discount method; you agree to repay lender $4,000 in 180 days using discount rate
of 10%. APR?
D = MRT = $4,000 10% 180
360 = $200 Discount method uses a 360-day year
R = I = $200 ~
~ .1067 ~
~ 10.67%
$3,800 180
PT
365
Use 365-day year for APR
U n i t 8 . 3 C o m p o u n d i n t e re s t
a Understanding how $5,000 for 3 years at 8% using (a) simple interest, and (b) interest compounded annually:
compound interest a. I = PRT = $5,000 8% 3 = $1,200 M = P + I = $5,000 + $1,200 = $6,200
differs from simple b. Balance
interest Yr. 1: I = PRT = $5,000 8% 1 = $400 M = P + I = $5,000 + $400 = $5,400
Yr. 2: I = PRT = $5,400 8% 1 = $432 M = P + I = $5,400 + $432 = $5,832
Yr. 3: I = PRT = $5,832 8% 1 = $466.56 M = P + I = $5,832 + $466.56 = $6,298.56
b Computing Periodic rate for 9.75% compounded quarterly: 9.75 = 2.4375(%)
4
compound interest
for different Deposit $500 for 1 year at 9.75% compounded quarterly. Ending balance?
compounding
periods Interest Balance
Beginning $500.00
3 months $500.00 2.4375% = $12.19 $512.19
6 months $512.19 2.4375% = $12.48 $524.67
9 months $524.67 2.4375% = $12.79 $537.46
12 months $537.46 2.4375% = $13.10 $550.56
1. Suppose your business borrows some money. Who benefits from calculating interest using a
Critical 360-day yearyou or the lenderand why?
Thinking 2. In Unit 8.2, formulas for P, R, and T are derived from the formula I = PRT. Using equation-
solving skills, show how these three formulas are derived.
3. If you get a loan with a front-end fee, why is the APR greater than the stated annual rate?
4. If you get a loan using the discount method, why is the APR greater than the stated annual rate?
5. Explain why you would rather earn compound interest than simple interest.
6. Explain why you are better off earning 6% interest compounded quarterly than 6% interest com-
pounded semiannually.
For Problems 16 and 17, we will calculate interest on a 13% 90-day $15,000 loan.
16. Calculate interest, assuming the lender uses a 360-day year.
90 = $487.50
I = PRT = $15,000 13% 360
17. Calculate interest, assuming the lender uses a 365-day year.
90 = $480.82
I = PRT = $15,000 13% 365
I P R T
26. $320.83 $5,000 11% 7 months
27. $63.75 $4,500 8.5% 2 months
28. 2,964.75 $35,400 16.75% 6 months
29. $275 $2,000 11% 1.25 yrs = 15 months
30. You open a checking account. You are paid 3% interest on the average balance but are charged a $7 monthly charge.
Assuming that interest is paid monthly (regardless of the number of days in the month), calculate the average daily
balance you must maintain to offset the $7 monthly charge.
I
($7) I =
P = RT $7 = .03 $7 $7 = $2,800
= .0025
3% 12
1 1 12
P R T 1 = $7.00
(?) (3%) (121 ) Check answer: I = PRT = $2,800 3% 12
32. You borrow $200 from your aunt and agree to repay her $225 ($200 principal + $25 interest) in 18 months. What
interest rate are you paying?
I
($25)
I =
R = PT $25 $25 .0833 8.33%
= $300
P R T $200 12
18
($200) (?) (18
12 )
33. You get a 180-day $5,000 consumer loan at 9%. You are required to pay a $100 setup fee at the time you get the loan.
What is your APR?
Principal (P) for APR purposes is the amount of money you have use of: $5,000 - $100 fee = $4,900
Interest (I) for APR purposes is total finance charges:
I = PRT = $5,000 9% 180
365 = $221.92
Set-up fee + 100.00
Total finance charges $321.92
I =
R = PT $321.92 $2,416.44
$321.92 .1332 13.32%
$4,900 180
365
34. You get a $3,500 loan for 90 days. Interest of 13% is charged, using a 360-day year. What is the APR?
90 = $113.75
I = PRT = $3,500 13% 360
I =
R = PT $113.75 $863.01
$113.75 .1318 13.18%
$3,500 365
90
Even though interest is calculated using a 360-day year, an APR always uses a 365-day year
35. You get a loan using the discount method. You sign a note, agreeing to repay the lender $2,000 in 60 days. Assuming
a discount rate of 15%, determine the APR.
60 = $50
D = MRT = $2,000 15% 360
Remember, the discount method uses a 360-day year to calculate interest
Proceeds = M - D = $2,000 - $50 = $1,950 (this is money you have use of)
I =
R = PT $50 $320.55
$50 .1560 15.60%
$1,950 60
365
Even though interest is calculated using a 360-day year, an APR always uses a 365-day year
Interest Balance
Beginning $700.00
1 year $700 5% = $35.00 $735.00
2 years $735 5% = $36.75 $771.75
3 years $771.75 5% = $38.59 $810.34
41. George Lavin deposits $700 in a savings account. The money is left on deposit for 3 years earning 5% compounded
semiannually. Calculate the account balance at the end of 3 years. Do not round intermediate results, but write amounts
to the nearest penny.
Interest Balance
Beginning $700.00
6 months $700 2.5% = $17.50 $717.50
12 months $717.50 2.5% = $17.94 $735.44
18 months $735.44 2.5% = $18.39 $753.82*
24 months $753.82 2.5% = $18.85 $772.67
30 months $772.67 2.5% = $19.32 $791.99
36 months $791.99 2.5% = $19.80 $811.79
42. Refer to Problems 3941. Who ended up with the most money, and why? George Lavin (Problem 41) ended up
with the most. The more often interest is compounded, the more interest is earned.
Challenge problems
43. Bob Green purchased merchandise from a supplier and failed to pay the invoice amount ($285) by the last day of the
credit period (August 23). Calculate the total amount Bob must pay on October 16 if the supplier charges 18% inter-
est on past-due accounts.
Number of days: Oct. 16 Day 289 I = PRT = $285 18% 365
54 = $7.59
Aug. 23
Day -235 M = P + I = $285 + $7.59 = $292.59
54
44. Alyce Lee, a sporting goods retailer, purchased ski clothing from a supplier for $2,450. The seller offers a 4% discount
if the invoice is paid within 10 days; if not paid within 10 days, the full amount must be paid within 30 days of the
I to find the annual rate Alyce, in effect, is paying the supplier if she fails to pay the
invoice date. Use the formula R = PT
invoice at the end of the discount period. Hint: Alyce is, in effect, borrowing the net amount (amount after deducting
the discount) for 20 days and must pay the difference as interest.
Invoice amount $2,450
Discount: $2,450 4% - 98
Net amount due $2,352
If Alyce fails to pay the invoice within the discount period she is, in effect, borrowing $2,352 for 20 days and pay-
ing an extra $98 as interest, so:
R = I = $98
20
= $98 .7604 76.04%
PT $2,352 365 $128.88
49. The ad to the right states that $1,000 left on deposit for 5 years earning
8.75% compounded semiannually would result in the same balance as
$1,000 earning 10.69% simple interest. Determine if the ad is correct.
First, find the maturity value using 10.69% simple interest. Then, find the
ending balance for 8.75% compounded semiannually.
10.69% simple interest
I = PRT = $1,000 10.69% 5 = $534.50
M = P + I = $1,000 + $534.50 = $1,534.50
8.75% compounded semiannually (lets use calculators)
Balance in 6 months: $1,000 + 4.375% = $1,043.75
Balance in 12 months: + 4.375% = $1,089.41
Balance in 18 months: + 4.375% = $1,137.08
Balance in 24 months: + 4.375% = $1,186.82
Balance in 30 months: + 4.375% = $1,238.75
Balance in 36 months: + 4.375% = $1,292.94
Balance in 42 months: + 4.375% = $1,349.51
Balance in 48 months: + 4.375% = $1,408.55
Balance in 54 months: + 4.375% = $1,470.17
Balance in 60 months: + 4.375% = $1,534.49
The ending balances are almost identical, showing that, for a 5-year
period, 10.69% simple interest is equivalent to 8.75% compounded
semiannually.
Practice Test
1. In the simple interest formula I = PRT, I stands for the interest rate. (T or F) False. I stands for the dollar amount of inter-
est; R stands for interest rate.
2. Lynette Read borrowed $12,000 at 9.5% interest for 8 months. What is the maturity value?
8
I = PRT = $12,000 9.5% 12 = $760 M = P + I = $12,000 + $760 = $12,760
3. On June 22, 2005, Lo Nguyen borrowed some money for 120 days. What is the maturity date?
June 22
Day 173 + 120 = 293
Oct. 20
7. You get a loan using the discount method. You sign a note, agreeing to repay the lender $30,000 in 180 days. Assuming
a discount rate of 13.5%, determine the APR.
D = MRT = $30,000 13.5% 180
360 = $2,025
Remember, the discount method uses a 360-day year to calculate interest
Proceeds = M - D = $30,000 - $2,025 = $27,975 (this is amount you have use of)
I =
R = PT $2,025 $13,795.89
$2,025 .1468 14.68%
$27,975 180
365
8. Kyle Santini deposits $500 in a savings account. The money is left on deposit earning 6% compounded semiannually.
Calculate the account balance at the end of 2 years.
Interest Balance
Beginning $500.00
6 months $500.00 3% = $15.00 $515.00
12 months $515.00 3% = $15.45 $530.45
18 months $530.45 3% = $15.91 $546.36
24 months $546.36 3% = $16.39 $562.75
Suggestions or Brainteaser
Comments Suppose someone agrees to pay you
1 today, 2 tomorrow, 4 the third
If you have any comments or sugges-
Linda, my interest in you is day, and keeps doubling the amount
tions about the text, please call the
compounding daily! each day. How much would you
publisher or author:
receive on day 40?
Publisher: 1-800-844-1856
Author: 1-800-6WEBBER
Answer: $5,497,558,138.88
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