Question

5. If your friend deposits $12,000 at 9% per year simple interest, what compound interest rate would yield the same amount of money in 5 years? Draw cash flow diagram.

Answer 1

Deposit amount (P) = $12,000

Rate of simple interest (R) = 9% per year = 0.09

N = 5 years

Total amount after 5 years using simple interest = P + (P*R*N) = 12,000 + (12,000 * 0.09 * 5) = 17,400

We will make this same amount lets say with X% per year compounding interest. Thus

17,400 = 12,000 (1 + X)⁵

as formula using compound interest is: Future value = P (1 + R)⁵

X = 7.7%

. (SI) i= g% 17,400 1277 (CI) 19.400 1 2 3 4 1 2 3 4 12,000 12,000 Simple Interest Compound Interest