WEEK
ENGINEERING ECONOMICS
ES5-T
3
COMPOUND INTEREST
Compound Interest
The interest earned by the principal which is added to the principal will
also earn an interest for the succeeding periods.
F = P(1 + i) n
where
P = present worth of principal
F = compound amount at end of “n” periods
i = rate of interest
n = number of interest periods
(1+i)n = Single Payment Compound Amount Factor
COMPOUND INTEREST
Period Accumulated
Principal Interest
n Amount
P + I = P+ Pi = P(1+I)
P 1 I=Pi
P + I = P(1+i) + P(1+i) i
P(1+i) 2 I = P(1+i) i
= P(1+I)(1 + i) = P(1 + i)2
P + I = P(1+i)2 + P(1+i)2 i
P(1+i)2 3 I = P(1+i)2 i
= P(1+I)2(1 + i) = P(1 + i)3
P n I = P(1+i)n i F = P(1 + i)n
COMPOUND INTEREST
a) For 12% compounded annually for 5 years.
i = 0.12 n = 5 periods
b) For 12% compounded semi-annually for 5 years.
i = 0.12/2 = 0.06 n = 5(2) = 10 periods
c) For 12% compounded quarterly for 5 years.
i = 0.12/4 = 0.03 n = 5(4) = 20 periods
d) For 12% compounded monthly for 5 years.
i = 0.12/12 = 0.01 n = 5(12) = 60 periods
e) For 12% compounded bi-monthly for 5 years.
i = 0.12/6 = 0.02 n = 5(6) = 30 periods
COMPOUND INTEREST
Nominal Rate of interest
It specifies the rate of interest and the number of interest periods per
year.
Effective rate of interest
the actual rate of interest on the principal for one year.
COMPOUND INTEREST
COMPOUND INTEREST
COMPOUND INTEREST
Problem 1: At an interest rate of 10% compounded annually, how
much will a deposit of Php 5,000 be in 15 years?
𝐹 = 𝑃(1 + 𝑖)𝑛
𝐹 = 5000(1 + 0.1)15
𝐅 = 𝐏𝐡𝐩 𝟐𝟎, 𝟖𝟖𝟔. 𝟐𝟒
COMPOUND INTEREST
Problem 2: If the sum of Php 20,000 is deposited in an account earning
interest at the rate of 9% compounded quarterly, what will it become
at the end of 8 years?
𝐹 = 𝑃(1 + 𝑖)𝑛
0.09 8𝑥4
𝐹 = 20,000(1 + )
4
𝐅 = 𝐏𝐡𝐩 𝟒𝟎, 𝟕𝟔𝟐. 𝟎𝟔
COMPOUND INTEREST
Problem 3: Funds are deposited in a savings account at an interest rate
of 8% per annum. What is the initial amount that must be deposited to
yield a total of Php 100,000 in 10 years.
𝐹 = 𝑃(1 + 𝑖)𝑛
100,000 = 𝑃(1 + 0.08)10
𝐏 = 𝐏𝐡𝐩 𝟒𝟔, 𝟑𝟏𝟗. 𝟑𝟓
COMPOUND INTEREST
Problem 4: You borrow Php 3,[Link] for one year from a friend at an
interest rate of 1.5% per month instead of taking a loan from a bank at
a rate of 18% per year. Compare how much money will save or lose on
the transaction.
Friend: Bank:
𝐹 = 𝑃(1 + 𝑖)𝑛 𝐹 = 𝑃(1 + 𝑖)𝑛
𝐹 = 3500(1 + 0.015)12 𝐹 = 3500(1 + 0.18)1
𝐹 = 𝑃ℎ𝑝 4184.66 𝐹 = 𝑃ℎ𝑝 4130
𝐁𝐚𝐧𝐤: 𝐬𝐚𝐯𝐞 𝟓𝟒. 𝟔𝟔
COMPOUND INTEREST
Problem 5: A man who won Php 500,000 in a lottery decided to place
50% of his winning in a thrust fund for the college education of his son. If
the money will earn 14% per year compounded quarterly, how much
will the man have at the end of 10 years when his son will be starting his
college education?
𝐹 = 𝑃(1 + 𝑖)𝑛
0.14 10𝑥4
𝐹 = 250000(1 + )
4
𝑭 = 𝑷𝒉𝒑 𝟗𝟖𝟗, 𝟖𝟏𝟒. 𝟗𝟑
COMPOUND INTEREST
Problem 6: On his sixth birthday, a boy is left an inheritance. The
inheritance will be paid in a lump sum of Php 100,000 on his 21st
birthday. What is the present value of the inheritance as of the boy’s
sixth birthday if the interest is 4% compounded annually?
𝐹 = 𝑃(1 + 𝑖)𝑛
100,000 = 𝑃(1 + 0.04)15
𝑷 = 𝑷𝒉𝒑 𝟓𝟓, 𝟓𝟐𝟔. 𝟒𝟓
COMPOUND INTEREST
Problem 7: A business firm contemplating the installation of labor saving
machinery has a choice between two different models. Machine A will cost Php
36,500, while Machine B will cost Php 36,300. The repairs required for each
machine are as follows:
Machine A: Php 1,500 at the end of 5th year
Php 2,000 at the end of 10th year
Machine B: Php 3,800 at the end of 9th year
The machines are alike in all other aspects. If this firm is earning 7% return on its
capital, which machine should be purchased and what is the net savings?
0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9
1,500 2,000 3,800
COMPOUND INTEREST
Problem 8: A businessman wants to have Php 500,000 four years from
now. What amount should he invest now if it will earn interest of 6%
compounded quarterly for the first 2 years and 8% compounded semi-
annually during the next 2 years.
500,000
𝐹1 = 𝑃(1 + 𝑖)𝑛
0.06 2𝑋4
0 1 2 3 4 𝐹1 = 𝑃(1 + )
4
𝐹1 = 1.126492587𝑃
QUARTERLY SEMI-ANNUALLY
𝐹 = 𝑃(1 + 𝑖)𝑛
P F1 0.08 2𝑋2
500,000 = 1.126492587𝑃(1 + )
2
𝑷 = 𝑷𝒉𝒑 𝟑𝟕𝟗, 𝟒𝟎𝟗. 𝟓𝟗𝟒𝟓
COMPOUND INTEREST
Problem 9: In how many years is required for Php 2,000 to increase by
Php 3,000 if interest at 12% compounded semi-annually?
COMPOUND INTEREST
Problem 10: If the effective interest rate is equal to 19.56%, compute
the nominal rate if money is compounded monthly.
𝑖 12
0.1956 = (1 + ) −1
12
𝒊𝒏 = 𝟏𝟕. 𝟗𝟗𝟖%
CONTINUOUS COMPOUNDING
Continuous Compounding
Continuous compounding is present when the duration of the
compounding period becomes infinitely small and the number of times
interest is compounded per period becomes infinite.
F = Per n
CONTINUOUS COMPOUNDING
Problem 1: A nominal interest of 3 % compounded continuously is given
on the account. What is the accumulated amount of Php 10,000 after
10 years?
𝐹 = 𝑃𝑒 𝑟𝑛
𝐹 = (10,000)𝑒 0.03(10)
𝐅 = 𝐏𝐡𝐩 𝟏𝟑, 𝟒𝟗𝟖. 𝟓𝟗
CONTINUOUS COMPOUNDING
Problem 2: A man wishes to have Php 40,000 in a certain fund at the
end of 8 years. How much should he invest in a fund that will pay 6%
compounded continuously?
𝐹 = 𝑃𝑒 𝑟𝑛
40,000 = 𝑃𝑒 0.06(8)
𝐏 = 𝐏𝐡𝐩 𝟐𝟒, 𝟕𝟓𝟏. 𝟑𝟒
CONTINUOUS COMPOUNDING
Problem 3: Compute the difference in the future amount of Php 500
compounded annually at nominal rate of 5% and if it is compounded
continuously for 5 years at the same rate.
𝐹 = 𝑃(1 + 𝑖)𝑛
𝐹 = 500(1 + 0.05)5
𝑭 = 𝟔𝟑𝟖. 𝟏𝟒
𝐹 = 𝑃𝑒 𝑟𝑛
𝐹 = 500𝑒 0.05𝑥5
𝑭 = 𝟔𝟒𝟐. 𝟎𝟏
