Question

If you deposit $5,000 today in an account earning an annual rate of return of 9%, in the third year how much interest would be earned? How much results from compounding of interest?

Answer 1

Amount deposited = $5,000
Annual Interest Rate= 9%

Interest in Year 1 = $5,000 * 9%
Interest in Year 1 = $450

Balance after Year 1 = $5,000 + $450
Balance after Year 1 = $5,450

Interest in Year 2 = $5,450 * 9%
Interest in Year 2 = $490.50

Balance after Year 2 = $5,450 + $490.50
Balance after Year 2 = $5,940.50

Interest in Year 3 = $5,940.50 * 9%
Interest in Year 3 = $534.65

Interest if simple interest is used = $5,000 * 9%
Interest if simple interest is used = $450

Interest earned in third year is $534.65 and $84.65 ($534.65 - $450) results from compounding of interest.