Exercise: Simple vs Compound Interest

Essential Learning(s):
● Demonstrate an understanding of personal finance (i.e. Income, spending, banking, investments)

Learning Goal:
● I will understand the terminology needed to calculate simple and compound interest.

Your Task:

1. How much interest would you earn on a one time deposit of $2,500.00 with an
annual interest rate of 5 percent calculated with simple interest over 5 years? (first
year is already done for you) 4 marks

Years Beginning End of

During the Year
of the Year the Year
Year 1 $2500.00 $2500.00 x 5% (0.05) = $125 interest $2625
Year 2 $2625.00 $2500.00 x 5% (0.05) = $125 interest $2750
Year 3 $2750 $2500.00 x 5% (0.05) = $125 interest $2875
Year 4 $2875 $2500.00 x 5% (0.05) = $125 interest $3000
Year 5 $3000 $2500.00 x 5% (0.05) = $125 interest $3125

2. Using the Simple Interest Equation, determine if your answer above (question 1) is
correct. 2 marks

I=Pxrxn

= $2500 x 5% x 5
100
= $2500 x 0.05% x 5
= $625

- By the end of 5 years, I will earn a profit of $625.

 Total Investment with Interest = Principal + Interest

= $2500 + $625
= $3125

● Total Investment with Interest = $3125

3. If the same $2,500.00 is compounded annually for 5 years at 5 percent interest,

how much would you earn? (the first year is already done for you). 4 marks

Year Beginning of During the Year End of the

the Year Year

Year 1 $2500.00 $2500 x 0.05(5%) = $125.00 interest $2625.00

Year 2 $2625.00 $2625 x 0.05(5%) = $131.25 interest $2756.25

Year 3 $2756.25 $2756.25 x 0.05(5%) = $137.81 interest $2894.06

Year 4 $2894.06 $2894.06 x 0.05(5%) = $144.70 interest $3038.76

Year 5 $3038.76 $3038.76 x 0.05(5%) = $151.94 interest $3190.70

4. Using the Compound Interest Equation, determine if your answer above (question
3) is correct. 2 marks

I = P x (1+r)n - P

= $2500 x (1+0.05%)5 - $2500

= $2500 x (1.05%) 5 - $2500
= $2500 x (1.276281563) - $2500
= $3190.70 - $2500
= $690.70

- By the end of 5 years, I will earn a profit of $690.70.

 Total Investment with Interest = Principal + Interest

= $2500 + $690.70
= $3190.70

● Total Investment with Interest = $3190.70

5. Which one would you rather invest and receive - Simple Interest OR Compound
Interest? Why? What is the difference between the 2 examples with the amount of
money they would make? 1 mark

- I would invest in compound interest because it is a great investment, if you want

to receive more money than you can in simple interest. It will grow my money
faster than simple interest, as it increases the further interest calculations. This is
the reason why I think that investing in compound interest is better and more
beneficial than investing in simple interest.

- The difference between them is that simple interest is based on the principal
amount of a loan or deposit. And a compound interest is based on the principal
amount + the interest that accumulates on it in every interest period.

6. You have decided you want to buy a used car and decide to take out a loan for $15,000.00.
The bank offers you an 8% interest rate for a 4-year loan. 4 marks

a) If the loan is based on simple interest, what is the total amount of interest you would
pay? Show your work.

- I=Pxrxn

= $15,000 x 8% x 4
100
= $15,000 x 0.08% x 4
= $4800

● By the end of 4 years, I will have to pay $4800 more than I took from the bank.
 Total Investment with Interest = Principal + Interest

= $15,000 + $4800
= $19,800

● Total Investment with Interest = $19,800

- At the end of 4 years, I will have to return $19,800 in total to the bank.

b) If the loan is based on compound interest, what is the total amount of interest you would
pay?

- I = P x (1+r)n - P

= $15,000 x (1+0.08%)4 - $15,000

= $15,000 x (1.08%)4 - $15,000
= $15,000 x (1.36048896) - $15,000
= $20407.33 - $15,000
= $5407.33

● By the end of 4 years, I will have to pay $5407.33 more than I took from the bank.

Total Investment with Interest = Principal + Interest

= $15,000 + $5407.33
= $20,407.33

● Total Investment with Interest = $20,407.33

- At the end of 4 years, I will have to return $20,407.33 in total to the bank.
7. Complete the table below. 2 marks

When is it an advantage? When is it a disadvantage?

Simple Interest ● You can reduce the ● If the interest rate is

total interest paid by high, and you have
earning more than taken a loan, you will
your minimum have to pay more.
monthly payment,
leading you towards
your extra money.

Compound Interest ● You receive interest ● It sometimes can be

on the base amount more expensive than
(principal) + any you think. If the rates
interest accumulated. of return are higher, it
It allows you to grow will be a higher risk of
your money faster. loss than in simple
interest. You can lose
some or all of your
money.