STEPS IN CALCULATING COMPOUND INTEREST
Compound Interest- when interest earns interest. Compound interest can work to your advantage in a savings vehicle. Compound interest can be a disadvantage when you owe money. Example: Credit Card, car loan, etc.
FORMULA TO CALCULATE COMPOUND INTEREST P(1+r)n-P P = principal r = Annual interest rate divided by the number of compounding periods per year n = Total number of interest-compounding periods PROBLEM: On the day you were born your aunt put $1,000.00 in a Certificate of Deposit which pays 5% compounded monthly. On your 21st birthday, your aunt tells you about the CD and you may cash it in to help pay for college expenses. What is the total amount of your CD? STEP 1 Fill in parts of the formula: P(1+r)n-P P= $1000.00 r= 5%/12 (months per year) = .0041666 n = 21*12 (months per year) = 252 1,000(1+.0041666)252-1,000
STEP 2 Solve the inside bracket first. 1,000(1.00416660) 252 – 1,000 STEP 3 Calculate the number inside the bracket to the nth power. Use the scientific calculator: 1. key the number, 1.0041666 2. press x^y key, 3. type the n number, 252 1,000(2.85137641)-1,000 STEP 4 Multiply the Principal with the number inside the bracket. 1,000(2.85137641)-1,000= 2,851.38-1,000 STEP 5 Subtract the Principal from the interest. 2,851.38-1,000 = 1,851.38 Interest Earned = $1,851.38 Total amount in the CD = $2,851.38
Now it’s your turn: How much money would you have if you decided to keep the money in the CD until you are 65?