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Difference Between Simple Interest and Compound Interest

The document discusses the difference between simple and compound interest. Compound interest is calculated on the total balance which includes both the principal and accumulated interest from previous periods. This means the interest earns interest over time, leading to exponential growth, whereas simple interest only applies the interest rate to the original principal. The effect is minor over short periods but the difference grows significantly over longer time frames or with higher interest rates, as compound interest allows the balance to grow more substantially.

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Beboy Torregosa
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67 views3 pages

Difference Between Simple Interest and Compound Interest

The document discusses the difference between simple and compound interest. Compound interest is calculated on the total balance which includes both the principal and accumulated interest from previous periods. This means the interest earns interest over time, leading to exponential growth, whereas simple interest only applies the interest rate to the original principal. The effect is minor over short periods but the difference grows significantly over longer time frames or with higher interest rates, as compound interest allows the balance to grow more substantially.

Uploaded by

Beboy Torregosa
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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When interest is compounding, it means that when the next interest period arrives, it

takes into account the total balance, rather than just the principal.
For example, a $100 loan at 5% interest compounded annually will accrue a balance of $105
after one year.
The next year, however, instead of taking 5% of $100, the interest will be applied to
the total $105, making the new balance $110.25.

The next year the interest will be applied to that $110.25, and so on for the whole
length of the loan.
This is different from simple interest in which a consistent amount of money, derived
from a percentage of the principal, is paid to the holder of the loan periodically.
Because the same interest rate will be applied to an increasingly large balance, the growth
rate will be exponential.

This means that the difference between compounding interest and simple interest will
be minor over a short time (in the above example, only a $0.25 difference after two years) but
will grow more and more quickly as time goes on.

This also means that compounding interest is more sensitive to high interest rates,
since that will speed the growth even more, as well as extended time periods, which allow the
balance more room to grow.

DIFFERENCE BETWEEN SIMPLE INTEREST AND COMPOUND INTEREST


Compute the simple interest and the maturity value of a loan in the amount of Php
20000 at 4% payable in 5 years.
Solution:
I = Prt
I = (Php 20000)(.04)(5)
I = Php 4000
F=P+I
F = 20000 + 4000 = Php 24000

Compute the compound interest and compound amount of a loan of Php 20000 at 4% payable
in 5 years compounded annually.

Solution :
I = Prt I = Prt
I1= (20000)(.04)(1) I2= (20800)(.04)(1)
I1= Php 800 I2 = Php 832
A1 = 20000 + 800 A2= 20800 + 832
A 2= Php 20800
A2= Php 21632
I = Prt I = Prt
I3 = (21632)(.04)(1) I4 = (22497.28)(.04)(1)
I3 = Php 865.28 I4 = Php 899.8912
A3 = 21632 + 865.28 A4 = 22497.28 + 899.8912
A3 = Php 22497.28 A4 = 23397.1712

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I = Prt
I5 = (23397.1712)(.04)(1)
I5 = Php 935.886848
A5 = Php 24333.05805 = Php 24333.06

I = A – P = 24333.06 = Php4333.06

THE COMPOUND FORMULAS


A = P (1 + i)n
Where : A is the compound amount
P is the principal
1 is a constant in the formula
i = j/m ; j is the nominal rate and m is the
conversion period
n = mt ; t is the time in years
I=A-P

CONVERSION PERIODS
Daily m = 365
Weekly m = 48
Semi-monthly m = 24 ; every 15 days
Monthly m = 12
Quarterly m = 4 ; every 3 months
Semi-annually m = 2 ; every 6 months
Annually m=1

EXAMPLES
1) Compute the compound amount and the compound interest of a loan in the amount
of Php 20000 compounded annually at 4% payable in 5 years.
P = 20000 j = 4% = .04 m = 1 t=5

i = j/m = .04/1 = .04


n = mt = 1(5) = 5
A = P ( 1 + i)n
A = 20000 ( 1 + .04)5
A = 24333.05805 = Php 24333.06

I = 24333.06 – 20000
I = Php 4333.06

2) What is the compound amount of a loan of 45000 compounded quarterly at 7.5% in 3


years?

P = 45000 j = .075 m=4 t=3


i = .075/4 n = mt = 4(3) = 12

A = P (1 + i)n
A = 45000 (1 + .075/4)12
A = Php 56237.24

2|P age
3) How much is the compound interest if an investment of Php 100000 is compounded
monthly at 10% for 9 months?
P = 100000 j = .10 m = 12 t = 9 mo = 9/12
i = .10/12 n = mt = 12 (9/12) = 9
A = P (1 + i)n
A = 100000 (1 + .10/12)9
A = Php 107754.92
I=A–P
I = 107754.92 – 100000
I = Php 7754.92

4) Find the compound amount of a loan of Php 55000 compounded semi-annually at


9.3% for 11 years.

P = 55000 j = .093 m=2 t= 11


i = .093/2 n = mt = 2(11) = 22

A = P (1 + i)n
A = 55000 (1 + .093/2)22
A = Php 149494.70

5) How much is the compound interest of a loan of Php95000 compounded semi-


monthly at 5.2% in 13 months?
P = 95000 j = .052 m = 24 t = 13 mo
i = .052/24 n = mt = 24(13/12) = 26
A = P (1 + i)n
A = 95000 (1 + .052/24)26
A = Php 100499.15
I=A–P
I = 100499.15 – 95000
I = Php 5499.15

6) What is the compound amount of a loan of Php25000 compounded daily at 14% for 7
months? How much is the compound interest?

P = 25000 j = .14 m = 365 t = 7 mo


i = .14/365 n = 365 (7/12) = 2555/12
A = P (1 + i)n
A = 25000 (1 + .14/365)2555/12
A = Php 27126.93
I=A-P
I = 27126.93 - 25000
I = Php 2126.93

3|P age

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