Question

Let’s assume there is a firm that wants to invest $35,000 in a project with an interest rate of 10% annually, and that the project will last for five years. What will be the interests coming from the project if the firm chooses not to reinvest any of its earnings? What's the difference between simple and compound interests here?

Answer 1

Investment amount, P = $ 35,000

Interest rate, R = 10%

Number of years, n = 5 years

So, interest every year if the firm chooses not to reinvest any of its earnings = 10% * 35000 = $ 3,500

Simple Interest over the period of 5 years = PNR/100 = 35,000 * 5 * 10% = $ 17,500

If compounded annually,

Amount at Compound Interest after 5 years = P*(1+r)^n = 35,000 *(1+10%)^5 = $ 56,367.85

So, Compound Interest = 56,367.85 - 35,000 = $ 21,367.85

Difference between Simple and Compound Interest = 21,367.85 - 17,500 = $ 3,867.85

ie Compound Interest amount is greater than Simple Interest by $ 3867.85