Chapter 8

Simple and Compound Interest

Simple Interest

Suppose $1.00 were loaned today for one year at simple interest of 7 percent payable at maturity. One year hence the creditor would receive the following:

Principal $1.00
Plus Interest @ 7% .07
Total $1.07

The generalized formula for this total repayment is extremely simple. If P (principal) is invested today at simple interest rate R (expressed as a decimal, e.g., not 7 percent but .07), then the payment received T years hence (number of interest periods which, in this case, equals the number of years) will be:

P + (T × R × P)

which can be usefully simplified to be

P (1 + TR)

or as in the above example,

$1 (1 + 1 × .07) = $1 (1 + .07) = $1.07

The annual growth factor at 7 percent ...

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