A large part of business activity is based on money that can be loaned or borrowed. When money is loaned, there is always a risk that it may not be returned. A sum of money called interest is the inducement offered to make the risk acceptable.
When money is borrowed, interest is paid for the use of the money over a period of time. Conversely, when money is loaned, interest is received.
The amount of a loan is known as the principal. The longer the period of time for which the principal is loaned, the greater the total amount of interest paid. Thus, the future worth of the money F is greater than its present worth P. The relationship between F and P depends on the type of interest used.
Table below gives examples of compound-interest factors and example compound-interest calculations.
Simple Interest
When simple interest is used, F and P are related by
F = P(1 + ni)
where i is the fractional interest rate per period and n is the number of interest periods. Normally, the interest period is 1 year, in which case i is known as the effective interest rate.
Table Cash Flow For Two Project
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