Thursday, September 27, 2012

TIME VALUE OF MONEY: Simple Interest-


Simple interest is interest that is computed only on the original sum and not on accrued interest. Thus if you were to loan a present sumof moneyP to someone at a simple annual interest rate i (stated as a decimal) for a period of n years, the amount of interest you would receive fromthe loan would be:


At the end of n years the amountofmoneydue you, F, would equal the amount of the loan P plus the total interest earned. That is, the amount of money due at the end of the loan would be


EXAMPLE 3-3

You have agreed to loan a friend $5000 for 5 years at a simple interest rate of 8% per year. How much interest will you receive from the loan'? How much will your friend pay you at the end of 5 years?

SOLUTION


In Example 3-3 the interest earned at the end of the first year is (5000)(0.08)(1) = $400, but his money is not paid to the lender until the end of the fifth year. As a result, the borrower has the use of the $400 for four years without paying any interest on it. This is how simple interest works, and it is easy to seewhy lenders seldom agree to make simple interest loans.

No comments:

Post a Comment