After studying this appendix, you should be able to:
LEARNING OBJECTIVE 1
Distinguish between simple and compound interest.
Would you rather receive $1,000 today or a year from now? You should prefer to receive the $1,000 today because you can invest the $1,000 and earn interest on it. As a result, you will have more than $1,000 a year from now. What this example illustrates is the concept of the time value of money. Everyone prefers to receive money today rather than the same amount in the future because of the interest factor.
Interest is payment for the use of another person's money. It is the difference between the amount borrowed or invested (called the principal) and the amount repaid or collected. The amount of interest to be paid or collected is usually stated as a rate over a specific period of time. The rate of interest is generally stated as an annual rate.
The amount of interest involved in any financing transaction is based on three elements: