Flexible Learning A.Y.

2020-2021
DISTANCE EDUCATION COURSE GUIDE USING OBTL DESIGN v1

Discount Interest - like simple interest, discount interest is an amount paid for
borrowing money. However, unlike simple interest which is paid at the end of the loan
period, discount interest is charged in advance and is taken from the amount of loan
applied for on the origin date.
Let:d = discount interest rate
i = simple interest rate
If N = 1:
d
i=
1- d

If N≠ 1:
Id = F dN
P = F (1- dN )

Ex.1. A man borrows ₱10,000 from a loan firm, the rate of simple interest is 15%, but the
interest is to be deducted from the loan at the time the money is borrowed. At the end of
one year, he has to pay back ₱10,000. What is the actual rate of interest?
Given: F = ₱10,000
N=1
d = 15% (discount interest)

Req’d: i (actual interest)

Sol’n: P = 10,000 - 10,000 (0.15)
=₱ 8,500

I
i=
P
F - P 10,000 - 8,500
i= =
p 8,500
i = 0.1764705882
i = 17.65%

Ex.2. Peter borrowed money from a bank. He received from the bank only ₱13,400 an
promised to pay ₱15,000 at the end of 9 months. Determine the following:
a) Simple interest rate,
b) The corresponding discount rate or often referred to as “Bankers discount”.
Sol’n:
a) F = P + I
15,000 = 13,400 + I
I = 1,600
I = PiN
æ 9ö æ 9ö
1600 = (13,400 ) i ç ÷ 1600 = (13,400 ) i ç ÷
è 12 ø è 12 ø
i = 0.1592039801 i = 0.1592039801
i = 15.92% i = 15.92%

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DISTANCE EDUCATION COURSE GUIDE USING OBTL DESIGN v1

Compound Interest - the interest for an interest period is calculated on the principal
plus total amount of interest accumulated in previous periods. It means “interest on top of
interest”.
F
F = P (1+ i )
N
P=
(1+ i )
N

Rates of Interest:
1. Nominal rate of interest (r) - basic annual rate of interest
r
i=
M
where: i = rate of interest per period
r = nominal interest rate
M = number of compounding periods in one year

2. Effective interest rate (ieff) - is the actual rate of interest on the principal for one year. It is
equal to the nominal rate of interest if the interest is compounded annually, but it is bigger
than the nominal rate of interest if the interest is compounded semi-annually, quarterly or
monthly.
M
æ r ö
ieff = ç 1+ ÷ - 1
è Mø
Ex.1.
… interest is 12% compounded quarterly.
M=4
r = 12%
i = 12% ÷ 4 = 3%
ieff = (1+0.03)4 = 12.55%

Ex.2.
… interest is 12% compounded monthly.
M = 12
r = 12%
i = 12% ÷ 12 = 1%
ieff = (1+0.03)12 = 12.68%

Ex.3.
… interest is 12% compounded annually.
M=1
r = i = ieff = 12%

INTEREST FORMULAS FOR DISCRETE COMPOUNDING AND DISCRETE CASH

FLOWS
Discrete compounding means that the interest is compounded at the end of each finite -
length period, such as month, quarter, semi-annual, or annual. Formulas assume

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DISTANCE EDUCATION COURSE GUIDE USING OBTL DESIGN v1

discrete (i.e. lump-sum) cash flows spaced at equal time intervals on a cash flow
diagram. Discrete interest formulas assume that i remains constant during the N
compounding periods. (Note: units of i and N should be consistent)

Discrete Compounding Interest

Factor Name
For Single Cash Flow:
F = P (1+ i )
N
Single payment compound amount
é 1 ù
P=F ê ú Single payment present worth
ê (1+ i ) N ú
ë û
For Uniform Series (Annuities):
é (1+ i ) N - 1 ù
F = Aê ú Uniform series compound amount
ê i ú
ë û
é (1+ i ) - 1 ù
N

P = Aê ú Uniform series present worth

ê i (1+ i ) N ú
ë û
é i ù
A= F ê ú Sinking fund
ê (1+ i ) N - 1 ú
ë û
é i (1+ i ) ù
N

A= Pê ú
ê (1+ i ) N - 1 ú Capital Recovery
ë û

Annuity (A) - is a series of equal payments occurring at equal periods of time.

CASH FLOW DIAGRAM - used to translate the worded problem into an illustration to
facilitate visualization and easier analysis of the problem.
↑ represents receipt or positive cash flow at the indicated period
↓ represents disbursement or negative cash flow at the indicated period

Example 1: A loan is acquired now and is to be paid in 2 years with a series of ₱5,000
semi-annual payments. If interest is 10% compounded semi-annually, how much was
the original amount received?

P
↑ 1 2 3 4 Semi-annual periods
↓ ↓ ↓ ↓
₱5,000 ₱5,000 ₱5,000 ₱5,000

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DISTANCE EDUCATION COURSE GUIDE USING OBTL DESIGN v1

Example 2: A man buys a house and lot worth ₱1,500,000 if paid in cash. On the
instalment basis, he pays ₱500,000 down payment; ₱300,000 at the end of one year;
₱400,000 at the end of two years and a final payment at the end of four years. Find the
final payment if interest is 14%.

P
₱1,500,000
↑ 1 2 3 4 years
↓ ↓ ↓ ↓
₱500,000 ₱300,000 ₱400,000 F4 = ?

Note: When nothing in the interest is specified, automatically assumed compounded

interest and compounding is annual i = 14% per year

Choose a base period where all cash will be translated to their corresponding values.
At that base period “sum of all arrows up is equal to sum of all arrows down”.
Tip: if projecting to the future - multiply by (1+i)N , if projecting to the past - divide by
(1+i)N , N = number of periods away from future or past

For example
If base period is period 4, the cash flow equation is
(1,500,000-500,000)(1.14)4 = F4 + 300,000(1.14)3 + 400,000(1.14)2
F4 = ₱724,656.96

For example
If base period is period 0, the cash flow equation is

F4 300,000 400,000
1,500,000 - 500,000 = + +
(1.14) (1.14) (1.14)
4 3 2

F4 = ₱724,656.96

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