Category: compound interest

Compound Interest (O Levels Maths Tuition)

Compound Interest

“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 = \displaystyle\boxed{P(1+\frac{i}{100})^n}

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.

Solution:

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 = \displaystyle\boxed{P(1+\frac{i}{100})^n=120000(1+\frac{5}{100})^5=153153.79}

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 = \displaystyle\boxed{P(1+\frac{i}{100})^n=1000(1+\frac{10}{100})^{50}=117390.85}

The amount would become around $117,000! Isn’t it amazing? This is why Maths is useful and fun.

Check out our Cool Math page for more Math fun facts!