COURSE CODE: ENGINEERING ECONOMY
Module 3
INTEREST & DISCOUNTS
Week 5-6: Sept. 28-Oct 4; Oct. 5-11; Oct. 12-18, 2020 | 1st Semester, S.Y. 2020-2021
Introduction
The charging of interest is justified from the viewpoint of the lender
because he has to forego the use of his money during the time it is borrowed,
and to compensate him also for the risk which he has to take in lending out his
COURSE MODULE
money. From the borrower’s viewpoint, it is usually advantageous to borrow
money if in so doing he will be able to earn more than the interest which he has
to pay.
Intended Learning Outcomes
ILO 3.1 Compute the interest, interest rate, present and future values of any
transactions involving money
ILO 3.2 Evaluate options involving interest rates in a business transaction.
Topic 1 - INTEREST
Definition:
From the viewpoint of the borrower, Interest (I) is the amount of money
paid for the use of borrowed capital. For the lender, it is the income
produced by the money or any form of capital which he has lent.
Types of Interests
1. Simple interest - The interest on borrowed money is said to be simple
interest if the interest to be paid is said to be directly proportional to the
length of time the amount or principal is borrowed.
2. Compound Interest – the interest earned by the principal is not paid at
the end of each period but is considered as added to the principal,
and therefore will also earn interest for the succeeding periods.
OTHER TERMS:
Principal – the amount of money borrowed, on which interest is
charged. Other terms: Principal Sum; Present worth;
Rate of Interest – is the amount earned by one unit of principal during a
unit of time. The amount of Interest, I, due per period as a proportion of
the mount lent, borrowed or deposited (1). Expressed in Percent or
decimal form.
1. SIMPLE INTEREST
It costs to borrow money. The rent fee one pays for the use of money is called
the interest. The amount of money that is being borrowed or loaned is called
the principal or present value. Simple interest is paid only on the original
amount borrowed. When the money is loaned out, the person who borrows
the money generally pays a fixed rate of interest on the principal for the time
period he keeps the money. Although the interest rate is often specified for
a year, it may be specified for a week, a month, or a quarter, etc.
The formula for simple interest is:
COURSE MODULE
(3.1) I = Pin where: I = Total interest earned by the Principal.
P = The Principal Amount
i = rate of interest expressed in decimal form
n = number of interest periods
The total amount paid, F, to be repaid, is equal to the sum of the principal
amount (P) and the total interest (I) paid.
(3.2) F=P+I
= P + Pin
(3.3) F = P(1+in)
Types of Simple Interests:
a. Ordinary Simple Interest – interest computed on the basis of one
banker’s year which is:
1 banker’s year = 12 months, 30 days per month
= 360 days
Formula: Ordinary Simple Interest, I = Pi _d_ (3.1.1)
360
b. Exact Simple Interest – interest based on the exact number of days
Ordinary year = 365 days
Leap year = 366 days
Formulas: Exact Simple Interest, I = Pi _d_ (ordinary year) (3.1.2)
365
I = Pi _d_ (leap year) (3.1.3)
366
Where d = number of days in the interest period.
Note:
Leap years are those years that are exactly divisible by four, have 29
days in February, but excluding the century years, i.e. 1900, 2000 etc.
Examples: 1996, 2004, 2008, 2012, etc.
Solved Problem 1
Determine the ordinary simple interest on P10,000, invested for 9
months and 10 days, if the interest rate is 12%.
Solution:
Based on one banker’s year:
d= 9 months x 30 days/month = 270 days
+ 10 days
d = 280 days
I = P i d_ = 10,000 (0.12) (280/360)
360
COURSE MODULE
I = P933.33
Solved Problem 2
Determine the ordinary and exact simple interests on P5,000 for the
period from January 15 to June 20, 1993 if the rate of interest is 14%.
Solution: the number of days, d:
Jan. 15 – 31 = 16 days
Feb. = 28 days (1993 is an ordinary year)
Mar. = 31 days
Apr. = 30 days
May = 31 days
June = 20 days
d = 156 days
Ordinary Simple Interest: I = Pi d/360
= 5,000 (0.14) (156/360)
= 5000 (.14) (0.4333)
I = P303.33
Exact Simple Interest: I = P i d/365 (1993 is an ordinary year)
= 5,000(.14)(156/365)
I = P299.18
Solved Problem 3
Determine the exact and ordinary simple interests on P12,000
invested for the period from January 16 to November 26, 2016, if the rate of
interest is 24%.
Solution:
The number of days, d:
Jan. 16-31 = 15 days Exact: I = Pi d/366
Feb. = 29 days (leap year) = 12,000(0.24)(315/366)
Mar. = 31 days I = P2,478.69
Apr. = 30 days Note: 2016 is a leap year
May = 31 days
June = 30 days Ord: I = Pi d/360
Jul = 31 days = 12,000(0.24)(315/360)
Aug. = 31 days I = P2,520.00
Sept. = 30 days .
Oct. = 31 days
Nov. = 26 days
d = 315 days
Solved Problem 4
Ursula borrows P600 for 5 months at a simple interest rate of 15% per year.
Find the interest, and the total amount she is obligated to pay.
Solution
The interest is computed by multiplying the principal with the interest rate
and the time.
I = Pin = 600(0.15) (5 months/12 months)
I = P37.50
The total amount, F is
COURSE MODULE
F=P+I = P600+P37.50
F = P637.50
Solved Problem 5
Jose deposited P2500 in an account that pays 6% simple interest. How
much money will he have at the end of 3 years?
Solution
The total amount or the future value is given by Formula 3.3
F=P(1+in) = P2500[1+(.06) (3)]
=P2,950
Solved Problem 6
Darnel owes a total of P3060 which includes 12% interest for the three years
he borrowed the money. How much did he originally borrow?
Solution
This time we are asked to compute the principal P via Equation 3.3
P3,060 = P[1+(0.12)(3)]
P3,060 = P(1.36)
3,060 = P
1.36
P = P2,250
Darnel originally borrowed P2,250
2. COMPOUND INTEREST
The interest, I, earned by the principal when invested at compound
interest is much more than that earned by the same when invested at simple
interest for the same number of interest periods.
Formula: F = P(1+i)n
where: F = Future amount
P = Present worth
i = Percent Interest rate , in decimal form
n = Interest period (in months, quarters, semi-annual, annual, etc.)
(1+i)n = “single payment compounded amount factor, SPCAF”
COURSE MODULE
SPCAF = (F/P, i%, n); (1+i)n = (F/P, i%, n)
Thus,
F = P(1+i)n
F = P(F/P, i%, n)
NOMINAL RATE OF INTEREST
In compound interest problems, the rate of interest usually used is the
nominal rate of interest, which specifies the rate of interest and the number of
interest periods per year.
Thus, a nominal rate of 8% compounded quarterly means that: there
are 4 interest periods each year, the interest rate per period being 8%/4 =2 %
or 0.02
In compound interest problems, interest rates, i% are compounded
over a parallel number compounding period, n. There are several methods of
compoundment:
Monthly compoundment = 12x per year
Bi-monthly compoundment = every 2 months = 6x per year
Quarterly compoundment = every 3 months = 4x per year
Semi-annual compoundment = every 6 months = twice a year
Annual compoundment = once a year
Solved Problem 7
If P12,000 is deposited into a savings account earning interest rate of 9%
compounded quarterly, how much will it amount to, 8 years from now?
Given:
P = 12,000
n = 8 years x 4 quarters/year = 32 qrtrs.
i = 0.09/4 = 0.0225
F = ? (“how much will it amount to after 8 years?”)
Solution:
F = P(1+i)n
= 12,000(1.0225)32
F = P24,457.24
Solved Problem 8
A man possesses a promissory note, due three years after, whose
maturity value is P67,004.80. if the rate of Interest is 10% compounded semi-
annually, what is the value of this note now?
Given: F = P67,004.80 n = 3 years x 2 semis/yr. = 6 semis
P=? i = 0.10/2 = 0.05 (compounded twice a year)
Solution: F = P(1+i)n
67,004.80 = P(1.05)6
67,004.80 = P(1.340096)
P = 67,004.80
1.340096
COURSE MODULE
P = 50,000
Solved Problem 9
At a certain interest rate compounded quarterly, P10,000 will grow
up to P45,000 in 15 years. What is the amount at the end of 10 years?
Note: There are two problems presented here. The unknown interest rate,
i%, and the future amount, F of the principal at the end of 10 years. We
need to solve for the interest rate first.
a. i% = ? Given: P = 10,000; F15 = 45,000; n15 = 15yrs x 4 qrtrs/yr = 60 qrtrs.
F = P(1+i)n 45,000 = 10,000(1+i)60
45,000 = (1+i)60
10,000
[4.5 = (1+1)60]1/60
4.51/60 = 1+i
1.025385 = 1+i
1.025385 – 1 = i
i = 0.025385 ≈ 2.538%
b. F10 = ? (Future amount in 10 years)
n = 10 yrs.x 4 qrtrs/yr.
= 40 quarters
F10 = P(1+i)40
= 10,000(1.025385)40
F10 = P27,257.02
EFFECTIVE RATE OF INTEREST
Effective rate of interest is the actual rate of interest on the principal, for
one year. It is equal to the nominal rate.
Example: Imagine P1.00 to be invested at the nominal rate of 8% annual
interest, compounded quarterly. This amount, after one (1) year, will become:
F = P (1+i)n where: n = 1 year x 4 qtrs./year = 4 quarters
i = 0.08/4 = 0.02
Annually: Quarterly:
F = 1.00(1.08)1 F = 1.00 (1.02)4
F = 1.08 F = P1.082432
Thus, the actual interest, I, earned is I =P-F or P0.082432 instead of only 0.08
centavos (8%)
meaning, the actual interest rate is 0.082432 or 8.24% which is greater than the
nominal interest rate of 8%, which further means that the more the Principal is
compounded, the higher the effective rate is from that of the nominal interest
rate.
Solved Problem 10
COURSE MODULE
Compare the accumulated values at the end of 10 years if P10,000
is invested at the interest rate of 12% per year, compounded: annually,
semi-annually, quarterly, bi-monthly, monthly, daily and continuously.
Note: Accumulated values means the Future amount, F.
a. Annually: n = 10 years x once/yr. = 10 years
i = 0.12/1 = 0.12
F = 10,000(1.12)10
F = 31,058.48
b. Semi-annual: n= 10 years x 2 semis/yr. = 20 semis
i = 0.12/2 = 0.06
F = 10,000(1.06)20
F = P32,071.35
c. Quarterly: n= 10 years x 4 quarters/yr. = 40 quarters
i = 0.12/4 = 0.03
F = 10,000(1.03)40
F = P32,620.40
d. Bi-monthly: n = 10 years x 6 bi-monthlies/yr. = 60 bi-monthlies
i = 0.12/6 = 0.02
F = 10,000(1.02)60
F = P32,810.31
e. Monthly: n = 10 years x 12 months/year = 120 months
i = 0.12/12 = 0.01
F = 10,000(1.01)120
F = P33.003.87
f. Daily: n= 10 years x 365 days/year = 3650 days
i = 0.12/365 = 0.000329
F = 10,000(1.000329)
F = P33,194.62
g. Continuous: F = Pein
F = 10,000e(0.12x10)
F = P33,201.17
Note: The accumulated amount, F (Future amount) increases as the
number of compounding period increases.
TOPIC 2 DISCOUNTS
Discount is the difference between what it is worth in the future and
its present worth.
Banks often deduct the simple interest from the loan amount at the
time that the loan is made. When this happens, we say the loan has
been discounted. The interest that is deducted is called the discount, and
the actual amount that is given to the borrower is called the proceeds. The
amount the borrower is obligated to repay is called the maturity value.
If an amount M is borrowed for a time t at a discount rate of r per
year, then the discount D, is
COURSE MODULE
D=M⋅r⋅t
The proceeds P, the actual amount the borrower gets, is given by
P=M−D
=M−M r t
or
P=M(1−rt), where interest rate r is expressed in decimals.
Solved Problem 11
Francisco borrows P1200 for 10 months at a simple interest rate of 15%
per year. Determine the discount and the proceeds.
Solution:
The discount D is the interest on the loan that the bank deducts from the
loan amount.
D=Mrt
D = P1200(0.15)( 10 )
12
D = P150
Therefore, the bank deducts P150 from the maturity value of P1200, and
gives Francisco P1050. Francisco is obligated to repay the bank P1200.
In this case, the discount, D = P150,
and the Proceeds:
P = P120 − P150
P = P1050
Solved Problem 12
If Francisco wants to receive P1200 for 10 months at a simple interest rate of 15% per
year, what amount of loan should he apply for?
Solution:
In this problem, we are given the proceeds, P and are being asked to find the
maturity value, M .
We have P = P1200, r=0.15 , t = 10/12 . We need to find M .
We know, P=M−D ; but also D=Mrt
therefore
COURSE MODULE
P=M−Mrt
= M(1−rt)
1200 = M[1−(0.15)(1012)]
We need to solve for M .
1200 = M (1−0.125)
1200 = M (0.875)
1200 =M
0.875
M= P1,371.43
Therefore, Francisco should ask for a loan for P1371.43.
The bank will discount P171.43 and Francisco will receive P1200.
References
• Arreola, Matias – Engineering Economy: A Systematic Approach to
Engineering Economy, 3rd Edition, Ken Inc., 1993
• Fraser, Niall M. and Jewkes, Elizabeth M. – Engineering Economics:
Financial Decision for Engineers, 5th Edition, Pearson Canada, Inc. 2013
• https://math.libretexts.org/Bookshelves/Applied_Mathematics/Book%3
A_Applied_Finite_Mathematics_(Sekhon_and_Bloom)/06%3A_Mathem
atics_of_Finance/6.01%3A_Simple_Interest_and_Discount
• (1) https://en.wikipedia.org/wiki/Interest_rate
Prepared by:
JUJO MADRIA-POBADORA
Faculty Member
Manufacturing Engineering Technology
