TIME
VALUE OF MONEY 3-3
Simple Interest
Calculating
simple interest
payment
Simple interest refers to the payment of interest on the principal
amount of an investment. Interest payments are made at a constant
absolute rate. The equation for computing simple interest earned or
paid is:
I = P x R x T
Where:
I = Interest payment
P = Principal
R = Rate of interest
T = Number of interest paying periods
Annual interest
Let's look at an example to illustrate the use of the formula. Suppose
that you borrow $160,000 for one year at a 12% annual rate. How
much is the interest payment at the end of the one year period? (The
interest rate is represented in decimal form for all of our calculations.
For example, twelve percent is 0.12.)
I
=
P x R x T
I
=
($160,000) x (0.12) x (1)
I
=
$19,200
Interest for
periods of less
than one year
For periods of less than one year, the annual interest is adjusted with
this formula:
I = P x R x (days/360)
This formula converts the time period to a fractional yearly
equivalent. For example, suppose that you borrow $100,000 for 90
days at a 10% annual rate. The calculation for interest is:
I = P x R x (days/360)
I = ($100,000) x (0.10) x (90/360)
I = $2,500
The interest for 90 days based on an annual rate of 10% is $2,500.