Question

If you want $1,000 three years from now and you earn 4 percent on your savings, how much do you need to deposit?

$1,000

$1,040

$1,030

$889

$885

Answer 1

Formula for compound interest can be used to calculate principal amount as:

A = P x (1 + i)ⁿ

P = A/(1+ i)ⁿ

Where,
   P = principle amount

   A = amount after maturity = $ 1,000
   i = compound interest = 4 % or 0.04 p.a.
   n = number of periods = 3 years x 1 = 3 periods

[Let the frequency of compounding be once in a year]

Putting the values in the above formula we get,

P = $ 1,000/(1 + 0.04)³

   = $ 1,000/(1.04)³

   = $ 1,000/1.124864

   = $ 888.9964 or $ 889

Hence option 4^th “ $ 889” is correct answer.