SIMPLE INTEREST McGraw-Hill/Irwin Chapter Ten Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. LEARNING UNIT OBJECTIVES LU 10-1: Calculation of Simple Interest and Maturity Value 1. Calculate simple interest and maturity value for months and years. 2. Calculate simple interest and maturity value by (a) exact interest and (b) ordinary interest. LU 10-2: Finding Unknown in Simple Interest Formula 1. Using the interest formula, calculate the unknown when the other two (principal, rate, or time) are given. LU 10-3: U.S. Rule -- Making Partial Note Payments before Due Date 1. List the steps to complete the U.S. Rule. 2. Complete the proper interest credits under the U.S. Rule. 10-2 MATURITY VALUE Maturity Value (MV) = Principal (P) + Interest (I) The amount of the loan (face value) Cost of borrowing money 10-3 SIMPLE INTEREST FORMULA Simple Interest (I) = Principal (P) x Rate (R) x Time (T) Stated as a Percent Stated in Years Example: Jan Carley borrowed $30,000 for office furniture. The loan was for 6 months at an annual interest rate of 8%. What are Jan’s interest and maturity value? I = $30,000 x .08 x 6 = $1,200 interest 12 MV = $30,000 + $1,200 = $31,200 maturity value 10-4 SIMPLE INTEREST FORMULA Simple Interest (I) = Principal (P) x Rate (R) x Time (T) Stated as a Percent Stated in years Example: Jan borrowed $30,000. The loan was for 1 year at a rate of 8%. What is interest and maturity value? I = $30,000 x .08 x 1 = $2,400 interest MV = $30,000 + $2,400 = $32,400 maturity value 10-5 TWO METHODS OF CALCULATING SIMPLE INTEREST AND MATURIT Y VALUE Method 1: Exact Interest Used by Federal Reserve banks and the federal government Exact Interest (365 Days) Time = Exact number of days 365 10-6 METHOD 1: EXACT INTEREST On March 4, Peg Carry borrowed $40,000 at 8%. Interest and principal are due on July 6. Exact Interest (365 Days) I=PxRxT $40,000 x .08 x 124 = $1,087.12 interest 365 MV = P + I $40,000 + $1,087.12 = $41,087.12 maturity value 10-7 TWO METHODS OF CALCULATING SIMPLE INTEREST AND MATURITY VALUE Method 2 : Ordinary Interest (Banker’s Rule) Ordinary Interest (360 Days) Time = Exact number of days 360 10-8 METHOD 2 ORDINARY INTEREST On March 4, Peg Carry borrowed $40,000 at 8%. Interest and principal are due on July 6. Ordinary Interest (360 Days) I=PxRxT $40,000 x .08 x 124 = $1,002.22 interest 360 MV = P + I $40,000 + $1102.22 = $41,102.22 maturity value 10-9 TWO METHODS OF CALCULATING SIMPLE INTEREST AND MATURITY VALUE On May 4, Dawn Kristal borrowed $15,000 at 8%. Interest and principal are due on August 10. Exact Interest (365 Days) I=PXRXT Ordinary Interest (360 Days) I=PXRXT $15,000 x .08 x 98 = $322.19 interest 365 $15,000 x .08 x 98 = $326.67 interest 360 MV = P + I $15,000 + $322.19 = $15,322.19 MV = P + I $15,000 + $326.67 = $15,326.67 10-10 FINDING UNKNOWN IN SIMPLE INTEREST FORMULA: PRINCIPAL Principal = Interest Rate x Time Example: Tim Jarvis paid the bank $19.48 interest at 9.5% for 90 days. How much did Tim borrow using the ordinary interest method? P = $19.48 . = $820.21 .095 x (90/360) .095 times 90 divided by 360. (Do not round answer.) Interest (I) = Principal (P) x Rate (R) x Time (T) Check 19.48 = 820.21 x .095 x 90/360 10-11 FINDING UNKNOWN IN SIMPLE INTEREST FORMULA: RATE Rate = Interest Principal x Time Example: Tim Jarvis borrowed $820.21 from a bank. Tim’s interest is $19.48 for 90 days. What rate of interest did Tim pay using the ordinary interest method? $19.48 . R = $820.21 x (90/360) = 9.5% Interest (I) = Principal (P) x Rate (R) x Time (T) Check 19.48 = 820.21 x .095 x 90/360 10-12 FINDING UNKNOWN IN SIMPLE INTEREST FORMULA: TIME Time (years) = Interest Principle x Rate Example: Tim Jarvis borrowed $820.21 from a bank. Tim’s interest is $19.48 for 90 days. What rate of interest did Tim pay using ordinary interest method? T = $19.48 = .25. $820.21 x .095 .25 x 360 = 90 days Convert years to days (assume 360 days) Interest (I) = Principal (P) x Rate (R) x Time (T) Check 19.48 = 820.21 x .095 x 90/360 10-13 U.S. RULE - MAKING PARTIAL NOTE PAYMENTS BEFORE DUE DATE Any partial loan payment first covers any interest that has built up. The remainder of the partial payment reduces the loan principal. Allows the borrower to receive proper interest credits. 10-14 U.S. RULE (EXAMPLE) Joe Mill owes $5,000 on an 11%, 90-day note. On day 50, Joe pays $600 on the note. On day 80, Joe makes an $800 additional payment. Assume a 360-day year. What is Joe’s adjusted balance after day 50 and after day 80? What is the ending balance due? Step 1. Calculate interest on principal from date of loan to date of first principal payment. Step 2. Apply partial payment to interest due. Subtract remainder of payment from principal. $5,000 x .11 x 50 = $76.39 360 $600 -- 76.39 = $523.61 $5,000 – 523.61 = $4,476.39 10-15 U.S. RULE (EXAMPLE, CONTINUED) Joe Mill owes $5,000 on an 11%, 90-day note. On day 50, Joe pays $600 on the note. On day 80, Joe makes an $800 additional payment. Assume a 360-day year. What is Joe’s adjusted balance after day 50 and after day 80? What is the ending balance due? Step 3. Calculate interest on adjusted balance that starts from previous payment date and goes to new payment date. Then apply Step 2. $4,476.39 x .11 x 30 = $41.03 360 $800 -- 41.03 = $758.97 $4,476.39 – 758.97 = $3717.42 Step 4. At maturity, calculate interest from last partial payment. Add this interest to adjusted balance. $3,717.42 x .11 x 10 360 = $11.36 $3,717.42 + $11.36 = $3,728.78 10-16