7e Contemporary Mathematics FOR BUSINESS AND CONSUMERS Brechner

Compound Interest
and Present Value
PowerPoint Presentation by Domenic Tavella, MBA
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7e

PERFORMANCE OBJECTIVES
Section I Compound Interest—The Time Value of Money

11-1: Manually calculating compound amount (future

value) and compound interests
11-2: Computing compound amount (future value) and
compound interest by using compound interest tables
11-3: Creating compound interest table factors for periods
beyond the table
11-4: Calculating annual percentage yield (APY) or
effective interest rate
11-5: Calculating compound amount (future value) by
using the compound interest formula

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7e

PERFORMANCE OBJECTIVES continued

Section II Present Value

11-6: Calculating the present value of a
future amount by using present value tables
11-7: Creating present value table factors
for periods beyond the table
11-8: Calculating present value of a future
amount by using the present value formula

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7e

Compound Interest—The Time Value of Money

compound interest
• Interest that is applied a number of times during the
term of a loan or investment.
• Interest paid on principal and previously earned
interest.
time value of money
• The idea that money “now,” or in the present, is more
desirable than the same amount of money in the
future, because it can be invested and earn interest
as time goes by.

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7e

Compound Interest—The Time Value of Money

continued

compound amount, or future value (FV)

• The total amount of principal and accumulated
interest at the end of a loan or investment.
present amount, or present value (PV)
• An amount of money that must be deposited today,
at compound interest, to provide a specified lump
sum of money in the future.

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7e EXHIBIT 11-1
The Time Value of Money

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7e EXHIBIT 11-2
The Time Value of Money

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7e

Manually Calculating Compound Interest

Using the simple interest formula, I = PRT, calculate

the interest earned per period.
Each time interest is calculated, it is then added to the
principal to determine the new principal.
Compound interest = Compound amount – Principal

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7e

Calculating Compound Interest Example

What is the compound amount and the compound
interest of $10,000 at 12% interest, compounded
semiannually for 3 years?
Original principal = 10,000.00
Interest period 1 = PRT = 10,000.00 × .12 × .5 = + 600.00
Principal period 2 = 10,600.00
Interest period 2 = PRT = 10,600.00 × .12 × .5 = + 636.00
Principal period 3 = 11,236.00
Interest period 3 = PRT = 11,236.00 × .12 × .5 = + 674.16
Principal period 4 = 11,910.16
Interest period 4 = PRT = 11,910.16 × .12 × .5 = + 714.61
Principal period 5 =
Interest period 5 = PRT =12,624.77
12,624.77 × .12 × .5 = + 757.49
Principal period 6 = 13,382.26
Interest period 6 = PRT = 13,382.26 × .12 × .5 = + 802.94
Compound amount =
Original principal = -10,000.00
14,185.20
Compound interest = 4,185.20 9
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7e
Computing Compound Amount (Future Value) and
Compound Interest By Using Compound Interest Tables

Compound amount (future value)

• Table factor × Principal
Compounding periods
• Years × Periods per year
Interest rate per period
• Nominal rate
Periods per year

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7e TABLE 11-1
Compound Interest Table (Future Value of $1 at Compound Interest)

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7e EXHIBIT 11-3
Compounding Periods per Year

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7e

STEPS FOR USING COMPOUND INTEREST TABLES

STEP 1 Scan across the top row to find the interest rate per
period.
STEP 2 Look down that column to the row corresponding
to the number of periods.
STEP 3 The table factor at the intersection of the rate-per-
period column and the number-of-periods row is
the future value of $1 at compound interest.
Multiply the table factor by the principal to
determine the compound amount.
Compound amount = Table factor × Principal

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7e

Using Compound Interest Tables Example

Compounding periods = years  periods per year

• Compounding periods = 3 × 2 = 6
• Interest rate per period = nominal rate ÷ periods per
year
• Interest rate period = 12% ÷ 2 = 6%
• Compound amount (FV) = table factor  principal
• Compound amount (FV) = 1.41852  10,000 = 14,185.20
• Compound interest =
14,185.20 – 10,000 = 4,185.20

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7e
FOR CREATING NEW COMPOUND INTEREST
STEPS TABLE FACTORS

STEP 1 For the stated interest rate per period, find the two
table factors that represent half, or values as close
as possible to half, of the periods required.
STEP 2 Multiply the two table factors from Step 1 to form
the new factor.
STEP 3 Round the new factor to five decimal places.

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7e

Creating Compound Interest Table Factors for

Periods Beyond the Table Example

Calculate a new table factor and find the compound

amount of $3,500 invested at 16% interest
compounded quarterly, for 7 years.

Interest rate per period = 16% ÷ 4 = 4%

Compounding periods = 7  4 = 28

4%, 14 periods = 1.73168

4%, 14 periods =  1.73168
28 periods 2.9987156
Rounded new table value = 2.99872
 3,500
Compounded amount = $10,495.52

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7e

Annual Percentage Yield (APY) or Effective

Interest Rate

annual or nominal rate

• The advertised or stated interest rate of an
investment or loan.
• The rate used to calculate the compound interest.
annual percentage yield (APY) or effective rate
• The real or true rate of return on an investment.
• It is the total compound interest earned in 1 year
divided by the principal.
• The more compounding periods per year, the higher
the APY.

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7e EXHIBIT 11-4
Compound Interest Earned on $100 at 12%

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7e

Calculating Annual Percentage Yield (APY) or

Effective Interest Rate

What is the compound amount, compound interest,

and annual percentage yield of $7,000 invested for 1
year, at 6% interest, compounded quarterly.
Interest rate per period = 6% ÷ 4 = 1.5%
Compound periods = 1  4 = 4
Compound amount = 1.06136  7,000 = $7,429.52
Compound interest = 7,492.52 – 7,000 = $429.52

Total compound interest in 1 year 429.52

APY    6.14%
Principal 7 ,000.00

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7e

Calculating Compound Amount (Future Value) by

Using the Compound Interest Formula

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7e

STEPS FOR USING PRESENT VALUE TABLES

STEP 1 Add the 1 and the interest rate per period, i.

STEP 2 Raise the sum from Step 1 to the nth (number of
compounding periods) power by using the yx key on
your calculator.
STEP 3 Multiply the principal, P, by the answer from Step
2.

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7e

STEPS FOR USING PRESENT VALUE TABLES

STEP 1 Scan across the top row to find the interest rate per
period.
STEP 2 Look down that column to the row corresponding
to the number of periods.
STEP 3 The table factor found at the intersection of the
rate-per-period column and the number-of-periods
row is the present value of $1 at compound interest.
Multiply the table factor by the compound amount
to determine the present value.
Present value = Table factor × Compound amount (future value)

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7e EXHIBIT 11-5
Present Value to Future Value

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7e TABLE 11-2
Present Value Table (Present Value of $1 at Compound Interest)

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7e

Calculating Present Value

Use Table 11-2 to find how much must be invested
now at 8% interest compounded quarterly to have
$3,000,000, 3 years from now.
• Interest rate per period = 8% ÷ 4 = 2%
• Compounding periods = 3  4 = 12
• Present value = .78849  3,000,000 =
$2,365,470

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7e

STEPS FOR CREATING NEW TABLE FACTORS

STEP 1 For the stated interest rate per period, find the two
table factors that represent half, or values as close
as possible to half, of the periods required.
STEP 2 Multiply the two table factors from Step 1 to form
the new factor.
STEP 3 Round the new factor to five decimal places.

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7e

Creating Present Value Table Factors for Periods

Beyond the Table Example

Calculate a new table factor and find the present value

of $8,500, if the interest rate is 6% compounded
quarterly, for 10 years.
Interest rate per period = 6% ÷ 4 = 1.5%
Compound periods = 10  4 = 40
1.5%, 20 periods = .74247
1.5%, 20 periods =  .74247
1.5%, 40 periods = .5512617

New table factor (rounded)= .55126

 8,500
Present value of $8,500.00 = $4,685.71

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7e

Calculating the Present Value of a Future Amount

by Using the Present Value Formula

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7e

STEPS FOR SOLVING THE PRESENT VALUE FORMULA

STEP 1 Add the 1 and the interest rate per period, i.

STEP 2 Raise the sum from Step 1 to the nth power by
using the yx key on your calculator.
STEP 3 Divide the compound amount, A, by the answer
from step 2.

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7e CHAPTER REVIEW PROBLEM 1

A firm is planning to build five homes, each costing

$125,000, in 2 ½ years. The bank pays 6% interest
compounded semiannually. How much should the firm
invest now to have sufficient funds to build the homes
in the future?

Amount needed = 125,000  5 = $625,000

Interest rate per period = 6% ÷ 2 = 3%
Compound periods = 2.5  2 = 5
Present value = .86261  625,000 = $539,131.25

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7e CHAPTER REVIEW PROBLEM 2

As a savings plan for college, a family deposited

$10,000 in an account paying 8% compounded
annually when their son was born. How much will the
account be worth when their son is 18 years old?

Interest rate per period = 8% ÷ 1 = 8%

Compound periods = 18  1 = 18
Present value = 3.99602  10,000 = $39,960.20

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7e CHAPTER REVIEW PROBLEM 3

A firm deposited $500,000 in an account earning 12%

compounded monthly to pay for the future
construction of a warehouse. How much will be
available for the project in 2 ½ years?

Interest rate per period = 12% ÷ 12 = 1%

Compounding periods = 2.5  12 = 30

1%, 15 periods = 1.16097

1%, 15 periods =  1.16097
30 periods 1.34785

Rounded new table value = 1.34785

Amount deposited =  500,000
Compounded amount = $673,925.65
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7e CHAPTER REVIEW PROBLEM 4

A bank is offering a 6-year certificate of deposit (CD)

at 4% interest, compounded quarterly. What is the
annual percentage yield for an investment of $8,000?

Interest rate per period = 4% ÷ 4 = 1%

Compound periods = 1  4 = 4
Compound amount = 1.04060  8,000 = $8,324.80
Compound interest = 8,324.80 – 8,000 = $324.80

Total compound interest in 1 year

APY   324.80 
Principal 8,000.00
4.05%

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