Interest Rate

Interest Rate                

"It is the money paid for the use of money."

As we know that the objective of management should be to maximize shareholders wealth, and that this depends on the timing of cash flows.

For example

You take a loan of 1000 dollars from a bank. And you have to pay 1100 dollars at the end of the month. The interest rate will be 10% a month .i.e.

1000*10%=100

Interest rate expresses the time value of money. 

S

imple Interest

It is the interest that is paid on only the original amount, or principal borrowed.

The formula for calculating simple interest will be thus,

SI=P ( i ) (n)

Where

SI= Simple Interest in dollars

P= Principal or original amount borrowed

i= interest rate per time period

n=number of time periods

For example,

You deposit 1000 dollars in a saving account paying 5 percent simple interest for 10 years. At the end of 10 years, the amount of simple interest accumulated is determined as follows:

SI= P( i ) (n)

SI=1000(0.05)(10)

SI=500

C

ompound Interest

It is the interest paid on any previous interest as well as on the principal borrowed.

It implies that the interest paid on a loan is periodically added to the principle.

The formula for calculating compound interest will be thus,

For First Year,

CI= SI=P ( i ) (n)

For Second Year,

CI=SI(Year 1) + SI(i)(Year 1)

For Third Year,

CI=SI(Year 2) + SI(i)(Year 2)

And So On

Where,

CI=Compound Interest

SI= Simple Interest in dollars

P= Principal or original amount borrowed

i= interest rate per time period

n=number of time periods

For Example,

You deposit 1000 dollars in a saving account paying 5 percent simple interest for 10 years. At the end of 10 years, the amount of compound interest accumulated is determined as follows:

Years	Beginning Amount	Interest Earned (5%of beginning amount )	Ending Amount
1	$1000	50	1050
2	1050	52.5	1102.5
3	1102.5	55.125	1157.625
4	1157.625	57.88	1215.51
5	1215.51	60.77	1276.28
6	1276.28	63.81	1340.1
7	1340.1	67.00	1407.10
8	1407.10	70.35	1477.45
9	1477.45	73.87	1551.32
10	1551.32	77.57	1628.89