UDC2008: BUSINESS MATHEMATICS

CH 3: COMPOUND INTEREST
Prepared by: Mdm Nisa, UMCCed, 2025 1
 Learning Outcomes
By the end of this chapter, you should be able to
explain the concepts of time and value of money
derive the compound amount formula
use the compound amount formula to find the future value,
compound interest, and present value of investments and loans

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 3.1 Introduction
Compound interest computation is based on the principal, which
changes from time to time. Interest that is earned is compounded or
converted into principal and earns interest thereafter.

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 3.2 Compound Interest (Cont.)
Example 3.1
RM1,000 is invested for three years. Find the interest received at the
end of the three years if the investment earns 8% compounded interest
annually.
Solution
Year 0
Principal = RM1,000
Interest for first year = 1,000 × 0.08 × 1 = RM80

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 3.2 Compound Interest (Cont.)
Year 1
Amount at the end of first year = RM1,000 + RM80
= RM1,080
Interest for second year = 1,080 × 0.08 × 1 = RM86.40

Year 2
Amount at the end of second year = RM1,080 +RM86.40
= RM1,166.40
Interest for third year = 1,166.40 × 0.08 × 1 = RM93.31

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 3.2 Compound Interest (Cont.)
Year 3
Amount at the end of third year = RM1,166.40 + RM93.31
= RM1,259.71
Compound interest earned = Amount – Original Principal
= RM1,259.71 – RM1,000
= RM259.71

Note that interest computed for each year is based on the principal which
changes every year.
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 3.4 Compound Interest Formula
• Original principal, P, is the original amount invested.
• Future value S of an investment P after n interest periods is
S = P(1 + i)n
• Periodic interest rate i is the interest rate for each interest period
𝑘
𝑖=
𝑚
• where k is the annual nominal rate and m is the frequency of conversions.
• Number of interest periods n is the number of times interest is calculated
𝑛 = 𝑚𝑡.

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 Compound at the End of
Interest Compounded Frequency of conversion (m)
Every:
Annually 1 year 1

Semi-annually 6 months 2

Quarterly 3 months 4

Monthly 1 month 12

Every 2 months 2 months 6

Every 3 months 3 months 4

Daily 1 day 360

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 2.5 Simple Amount Formula
• Applying the future value formula to Example 3.1, we have
S = P (1 + i)n, where n = 3 for three years as interest rate is 8%
compounded annually.
S = 1,000(1 + 0.08)3
= RM1,259.71
Compound interest I is = S – P
= RM1,259.71 – RM1,000
= RM259.71

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 3.4 Compound Interest Formula (Cont.)
Example 3.2
Find the future value of RM1,000 which was invested for
a) 4 years at 4% compounded annually
b) 5 years 6 months at 14% compounded semi-annually
c) 2 years 3 months at 4% compounded quarterly
d) 5 years 7 months at 5% compounded monthly
e) 2 years 8 months at 9% compounded every 2 months
f) 250 days at 10% compounded daily.

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 3.4 Compound Interest Formula (Cont.)
• Solution
a) S = 1,000(1 + 4%)4 = RM1,169.86
14% 11
b) S = 1,000 (1 + 2
) = RM2,104.85

c) S = 1,000 (1 + 44%)9 = RM1,093.69

5% 67
d) S = 1,000 (1 + 12 ) = RM1,321.26
9% 16
e) S = 1,000 (1 + 6
) = RM1,268.99
10% 250
f) S = 1,000(1 + 360 ) = RM1,071.90
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 3.4 Compound Interest Formula (Cont.)
Example 3.3
RM9,000 is invested for seven years three months. This investment is
offered 12% compounded monthly for the first four years and 12%
compounded quarterly for the rest of the period. Calculate the future
value of this investment.

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 3.4 Compound Interest Formula (Cont.)
Solution

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 3.4 Compound Interest Formula (Cont.)
Amount of investment at the end of 4 years,
S4 = P(1 + i)n
12% 48
= 9,000(1 + 12 )
= RM14,510.03
Amount of investment at the end of 7 years 3 months,
S7 = P(1 + i)n
12% 13
= 14,510.03(1 + 4 )
= RM21,308.48

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 3.4 Compound Interest Formula (Cont.)
Example 3.5
Lolita saved RM5,000 in a savings account which pays 12% interest compounded
monthly. Eight months later she saved another RM5,000. Find the amount in the
account two years after her first saving.
Solution

Amount = 5,000(1 + 1%)24 + 5,000(1 + 1%)16

= RM12,211.57

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 3.7 Present Value
• The present value (or discounted value) at i% per interest period of an
amount S due in n interest periods is that value P which will yield the sum S
at the same interest rate after n interest periods.
• Hence present value,
S
P= (1 + i ) n
P = S(1 + i)–n
• The process of finding the present or discounted value is called discounting.

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 3.7 Present Value (Cont.)
Example 3.13
A debt of RM3,000 will mature in three years’ time. Find
a) the present value of this debt,
b) the value of this debt at the end of the first year, and
c) the value of this debt at the end of four years,
assuming money is worth 14% compounded semi-annually.

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 3.7 Present Value (Cont.)
Solution

a) From P = S(1 + i)–n, we get

14% –6
P0 = 3,000(1 + 2 )
= RM1,999.03

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 3.7 Present Value (Cont.)
b) P = S(1 + i)–n
14% –4
P1= 3,000 (1 + 2 )
= RM2,288.69

c) Here, we have to find S instead of P in the formula, S = P(1 + i)n as the value
of the debt to be determined is on the right side of the original debt.
From S = P(1 + i)n, we get
14% 2
S = 3,000(1 + 2 )
= RM3,434.70
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 LIST OF FORMULA FOR TODAY’S LESSON
COMPOUND INTEREST FORMULA
Future value S S = P(1 + i)n
𝑘
Periodic interest rate, i 𝑖 =
𝑚

Number of interest periods, n 𝑛 = 𝑚𝑡

Present Value (or Discounted Value) P= S

(1 + i ) n
P = S(1 + i)–n

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