Question

Alpha Company invests $12,000 at an interest rate of 12% for five years. What is the difference between simple and compound interests? Assume that in case the interest rate compounds monthly.

Answer 1

$ 9,800.36

Step-1:Calculation of simple interest for 5 years
Interest for 5 years	=	P	*	r	*	t
	=	$12,000	*	0.01	*	60
	=	$7,200
Where,
P	=	Principal			=	12,000
r	=	Interest rate	=	12%/12	=	0.01
t	=	Time	=	5*12	=	60
Step-2:Calculation of compound interest for 5 years
Interest for 5 years	=	Future Value of money	-	Present Value of money
	=	21,800.36	-	12,000.00
	=	9,800.36
Working:
Future Value of money		=FV(rate,nper,pmt,pv)
		21,800.36
Where,
rate	=	0.01
nper	=	60
pmt	=	0
pv	=	-12,000
Note:
Under compound interest method, interest is earned on principal and interest earned for subequent period.
For example,
Simple interest for 2 months:
Month 1	=	12000*0.01	=	120.00
Month 2	=	12000*0.01	=	120.00
Total interest for 2 months				240.00
Compound interest for 2 months:
Month 1	=	12000*0.01	=	120.00
Month 2	=	(12000+120)*0.01	=	121.20
Total interest for 2 months				241.20