“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein
The formula for Compound interest is:
Total Amount =
Where P=Principal amount (starting amount of money)
i = interest rate (in percent)
n = number of times compounded
We will illustrate this using an example:
Compound Interest Example Question
Source: Admiralty Secondary School Preliminary Examination 2011 Paper 2
Q: The cash price of a sports car is $420,000.
Mr Lionel buys it on compound interest loan terms. He pays a down payment of $300,000 and the balance at the end of 5 years with a compound interest rate of 5% per annum. Calculate the amount that Mr Lionel has to pay at the end of 5 years.
Firstly, we have to find out what is the balance. The balance would be $420,000-$300,000=$120,000.
That is the Principal amount, i.e. P=120,000. The interest rate, i=5. n=5 since the number of times compounded is 5 (once each year).
Hence, Total Amount =
In conclusion, he has to pay $153153.79 at the end of 5 years.
How is Compound Interest the Eighth Wonder of the World?
Imagine you have an amount of $1000. (P=1000)
And you manage to find a bank that pays 10% compound interest per annum. (i=10)
What happens after 50 years? (n=50)
Using the formula, Total Amount =
The amount would become around $117,000! Isn’t it amazing? This is why Maths is useful and fun.
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