Simple Interest Calculation Examples

Simple Interest

Simple interest is a concept in finance that refers to the cost of borrowing money or earning it in savings accounts. It represents the portion of a loan or deposit's total cost or value that directly depends on the length of time over which it is outstanding. While simple interest may seem like a straightforward concept, it has been debated by economists because it does not reflect the full cost of capital.

The formula for calculating simple interest is as follows:

A = P + I*T

where A equals the amount after t years (or months), P represents the principal (amount borrowed or deposit), I denotes the rate of simple interest (in decimal form), and T signifies the time period (years or months). For example, if you have $2000 saved as a deposit, the bank pays you 4% per annum simple interest. After one year, your deposit will earn $80 ($2000 x 0.04) per year. If you withdraw this money after two years, you would receive $80 * 2 = $160.

On the other hand, compound interest involves periodic increases in the base upon which interest is calculated. Compound interests can either be compounded annually, semi-annually, quarterly, monthly, daily or even continuously depending on the frequency specified by the financial institution offering the investment. In contrast, simple interest only needs to calculate the interest once during the entire tenure of the amount.

To better understand how simple interest works, consider the following examples:

Example 1

Assuming an individual deposits $750 with Bank X, the interest payable after 5 years, assuming the rate of interest is 6%, would be:

I = PRT = 750 @ 6% = $45

Amount due after 5 years would be: A = P + IT = 750 + 455 = $900

Thus, the individual would receive $900 from Bank X after 5 years.

Example 2

If a person deposits $32 and wants to multiply it by 5 times, using a simple interest on annual basis, we get:

P = R(1+r)^t - P = 32(1+0.06)^5 - 32 = $107.05

Thus, after 5 years, the amount deposited will be approximately $107.05.

In conclusion, understanding simple interest helps individuals make informed decisions when dealing with loans or savings. By knowing how much interest is charged or earned, people can plan their finances more effectively and avoid potential pitfalls related to borrowing or lending money.

Learn how to calculate simple interest and apply it in different scenarios with practical examples. Understand the difference between simple and compound interest and how they impact loans and savings accounts.