Compound Interest Formula

Compound Interest Formula

Future value Formula = P (1+r) n

P= Present Value

r= rate of interest

n= number of period

Compound Interest Formula Example

Bank Deposit= 200,000

Bank Rate of interest = 12%

Calculate future Value after three Years using Compound Interest?

Future value = P (1+r)ⁿ

= $ 200,000(1.12)³

= $200,000 x 1.4049

=$ 280,985

Interest for three years = future value – present value

= 280,956.8- 200,000

=80,985

Compound Interest Formula Calculation

Compound interest formula takes into account the capital amount and interest earned on the capital amount for interest calculation.

Use of Compound Interest formula

Compound interest is widely used for future value of the bonds. Compound interest formula is applied, where interest is paid on the maturity. Compound interest formula is not valid for regular interest payments.

Characteristics of Compound interest Formula

1.    Interest is paid at the maturity date

2.    Interest for each year is more than last year

3.    Offer higher return than simple interest

 Simple Interest & Compound Interest

Compound interest and simple interest are two different method of offering interest.  In simple interest a fixed amount of interest is offered each year (which may be paid periodically or on maturity).

In case of compound interest, the amount of interest is increasing each year and compound interest is paid on maturity along with capital amount.

 Compounding Vs Discounting

Compounding and discounting are two opposite concept. Compounding is calculation of future value based on a interest rate (Discounting Factor), While discounting is on other hand is a present value of future cash flows are amount. This concept has been explained with an example

Bank Deposit by a Person = 300,000

Bank Rate of interest or Discount Factor = 13%

Calculate future Value (Compounded Value & Discounted Value)?

Solutions

In first place we would calculate compounded value and then discounted value

Compounded Value

Future value = P (1+r)ⁿ

= $ 300,000(1.13)³

= $300,000 x 1.4428

=$ 432869

Discounted Value

Discounted Value = P (1+r)^-n

= 432869 x (1.13)^-3

=432869 x .6930

=300,000