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.

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