Simple Versus Compound Interest
Simple interest is the principal sum repaid for utilizing borrowed cash over a fixed duration. In this sense, it is computed by multiplying three components: the principal amount, time under consideration, and the rate of borrowing. Compound interest is the principal amount that incorporates all the past accrued interest (Weygandt et al., 2018) . It differs from simple interest, given that the time variable is used to raise the sum to the one and the interest rate. The principal sum is fixed in simple interest, while in compound interest, the principal sum keeps on fluctuating during the whole borrowing period. In addition, the interest is computed using the principal sum only, while in compound interest, the interest is computed using both the principal and total interest sums.
Present and Future Value Factors
The present value factor is related to the future value factor, given that the factor takes the latter and applies a specific interest or discount rate that could generate earnings if invested. In this sense, the present value factor represents the current value of a future cash amount at a particular return rate (Weygandt et al., 2018) . In this case, the future value factor can be obtained by charging the discount rate on both the present value factor and the total interest.
Delegate your assignment to our experts and they will do the rest.
Changes
When the present value factor decreases, the discount or interest proportion increases in a given duration. On the contrary, the factor decreases when the discount or interest proportion rises during the specified time period.
Ordinary Annuity and An Annuity Due
| Present value of $6000 ordinary annuity | $6000x((1-(1+0.1)^-10)/0.1)=$36,867.40 |
| Present value of $6000 annuity due | $6000+$6000x((1-(1+0.1)^-(11-1)/0.1)=$42867.40 |
The present value of the $6000 annuity due is more than the present value of the $6000 ordinary annuity by $6000. The greater amount is due to the fact that in annuity due payment is received at the beginning, while in ordinary annuity, it is received at the period's end.
Reference
Weygandt, J. J., Kieso, D. E., & Kimmel, P. D. (2018). Managerial accounting: Tools for business decision making . Hoboken, NJ: John Wiley & Sons, Inc.
