VALUER WORLD # COMPOUND INTEREST DEFINITION AND ITS FORMULA

Compound interest (or compounding interest) is interest calculated on the initial principal, which also includes all of the accumulated interest from previous periods on a deposit or loan. It is used to work out gross amount that would accumulate at the end of given period, on the principal sum, at the given rate of interest compounded at regular intervals. Here the interest is calculated every year on the new principal amount accounted by adding the interest gained on the previous year amount. Here interest is calculated on principal amount and also on the accumulated interest amount.

Total Interest factor ‘I’ = ( 1 + R )n

Gross Amount ‘A’ = P x ( 1 + R )n

‘R’ = Rate of compound interest

‘n’ = number of years

‘P’ = Principal Amount

‘A’ = Gross Amount receivable at end of given period.

Example :

A person deposits Rs.10,000/- in Bank at 5% compound interest rate for 7 years period. Calculate gross amount receivable after 7 years period including total interest amount on compound interest basis.

Solution :

A = P x (1 + R)n I = ( 1 + R )n

= ( 1 +5/100 )7

= 1.407

A = P x I

= 10,000 x 1.407

= 14,070

If Rs 10,000 is deposited for a period of 7 years at 5% interest compounded every year, the amount receivable at the end of 7 years will be Rs 14,070.

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