Financial Modeling Tutorials
 Financial Modeling Basics
 Excel Modeling
 Financial Functions in Excel
 Sensitivity Analysis in Excel
 Time Value of Money
 Future Value Formula
 Present Value Factor
 Perpetuity Formula
 Present Value vs Future Value
 Annuity vs Pension
 Present Value of an Annuity
 Doubling Time Formula
 Annuity Formula
 Annuity vs Perpetuity
 Annuity vs Lump Sum
 Internal Rate of Return (IRR)
 NPV vs XNPV
 NPV vs IRR
 NPV Formula
 PV vs NPV
 IRR vs ROI
 Break Even Point
 Payback Period & Discounted Payback Period
 Payback period Formula
 Discounted Payback Period Formula
 Profitability Index
 Cash Burn Rate
 Simple Interest
 Simple Interest vs Compound Interest
 Simple Interest Formula
 CAGR Formula (Compounded Annual Growth Rate)
 Effective Interest Rate
 Loan Amortization Schedule
 Mortgage Formula
 Loan Principal Amount
 Interest Rate Formula
 Rate of Return Formula
 Effective Annual Rate
 Effective Annual Rate Formula (EAR)
 Daily Compound Interest
 Monthly Compound Interest Formula
 Discount Rate vs Interest Rate
 Rule of 72
 Geometric Mean Return
 Real Rate of Return Formula
 Continuous compounding Formula
 Weighted average Formula
 Average Formula
 Average Rate of Return Formula
 Mean Formula
 Weighted Mean Formula
 Harmonic Mean Formula
 Median Formula in Statistics
 Range Formula
 Expected Value Formula
 Exponential Growth Formula
 Margin of Error Formula
 Decrease Percentage Formula
 Percent Error Formula
 Holding Period Return Formula
 Cost Benefit Analysis
 Cost Volume Profit Analysis
 Opportunity Cost Formula
 Mortgage APR vs Interest Rate
 Regression Formula
 Correlation Coefficient Formula
 Covariance Formula
 Coefficient of Variation Formula
 Sample Standard Deviation Formula
 Relative Standard Deviation Formula
 Volatility Formula
 Binomial Distribution Formula
 Quartile Formula
 P Value Formula
 Skewness Formula
 Regression vs ANOVA
What is Simple Interest?
Simple Interest is the charge which is imposed by the lender of money to the borrower for separating with their funds which could have been diverted elsewhere. It is computed on the Principal amount or on the amount of principal required to be paid off and is generally associated with loans which are short term in nature. It can be implemented on a yearly, monthly and daily basis.
Formula
The formula to calculate this interest is:
Simple Interest Formula = (P x R x T)/100
*whereby SI = Simple Interest
 P= Principal
 R= Rate of Interest
 T= Time period
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Examples
Let us consider the below example for a clearer understanding:
Example # 1
If Mr. A. borrows INR 10,000 from Mr. B. @ 8% for 5 years then at the end of 5^{th} year Mr. A has to pay:
SI = 10,000*8*5 = INR 400/100
The amount of INR 4000 is the Interest amount which has to be paid in addition to the Principal amount of INR 10,000. Thus, the final Amount = INR 10,000 + INR 4000 = INR 14,000.
All the abovementioned components play an important role in the arrival of the interest amount. If any of the component increases or decreases, it will have a direct impact on the final result.
It is usually applied to Shortterm personal loans or Automobile loans which generally have fixed time payment and not a very large amount of Principal to pay off. Simple interest is computed on a daily basis, it is most beneficial for customers who make their loan payments on a fixed date/monthly basis.
Example # 2
Mr. Z. borrowed $12,000 at 10% (SI) and lent the same sum of money to Mr. P. @ 15%. What will be the gain after 5 years?
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Since the rate of borrowing was 10% and lending rate is 15%, the gain is actually 5% [15% – 10%] for 1 year. Thus, to arrive at the gain, this difference is used as the ROI.
Given that T = 5 years and P = $12,000, the amount gained = $12,000 * 5 * 5% = $3,000
Installment and Simple Interests
The concept of the installment is extensively used in the finance world. When an individual wants to purchase a product, it is possible the individual may not have sufficient money to buy immediately. However, they can spread out the payment schedule over a given time frame i.e. make equal payments over the duration. Since installments are after a fixed interval, the lender is losing out on the opportunity of enhancing the money which could have fetched him more returns had the entire payment made at the time of initiation.
To compensate for the same, when every installment is made, a component of interest is also included with the Principal money as the Time, Value of Money.
Let us consider the below example:
What is the annual installment to discharge a debt of $7,700 due in 5 years with an ROI of 5%?
The installment paid at the end of the 1^{st}, 2^{nd}, 3^{rd}, 4^{th} and 5^{th} year shall result in the Simple interest paid for 4, 3,2,1,0 years respectively.
Let us start with an assumption that the downpayment is of $1000.


 At the end of 1^{st} year, amount paid will be = $1000 + {(5*4*100)/100} = $1020
 At the end of 2^{nd} year, amount paid will be = $1000 + {(5*3*100)/100} = $1015
 At the end of 3^{rd} year, amount paid will be = $1000 + {(5*2*100)/100} = $1010
 At the end of 4^{th} year, amount paid will be = $1000 + {(5*1*100)/100} = $1005
 At the end of 5^{th} year, amount paid will be = $1000

Thus, total amount paid = 1020+1015+1010+1005+1000 = $5050
This implies that for an amount of $5050, the annual instalment is $1,000 and therefore, for $7,700 the annual instalment with the component of Simple Interest:
(1000 * 7700) / 5050 = $1,524.75
In certain circumstances, the interest will not necessarily be charged on a yearly basis but could be quarterly, monthly or even a daily basis.
Let us look into another example:
A person lends $10,000 to a Corporation by purchasing a bond from them. It is computed on a quarterly basis at 3 percent per quarter, and a cheque for the interest is sent across every quarter to all the bondholders. The bonds expire at the end of 5 years, and the final cheque includes the original principal plus interest earned during the last quarter. What is the interest for every quarter and what will be the total interest earned over the 5year life of the bonds?
Given that P=$10,000, ROI = 0.03 per quarter with a time frame of 5 years. As the time period is on a quarterly basis, we shall consider 5 years = 20 quarters. Thus, quarterly interest:
SI = $10,000 * 0.03 * 1 = $300 for every quarter. Therefore, interest for 20 quarters = $300 * 20 = $6,000
Simple Interest vs Compound Interest
The concept of compound interest is used synonymously with Simple interest since it is a more accurate description of the interest amount earned. Let us study some of the differences between simple vs compound interest:
Simple Interest  Compound Interest 
It is the interest amount computed as a fixed percentage of the Principal Amount.  Interest amount as a percentage of the principal amount and the accumulated interest. It’s like Interest on Interest. 
The returns computed are less  Returns are on the higher side 
The principal remains constant  The principal keeps on changing during the duration of borrowing. The amount keeps on accumulating. 
Formula of Simple Interest = [P*R*T / 100]  Formula of Compound Interest = P*[1+r]^{t} 
Payment first goes towards interest component and remainder on the principal  Some of the monthly interest is added back to the loan for every succeeding month. Interest is paid on the old interest. 
This is charged on the Principal amount  Compound Interest is imposed on the Principal and the Accumulated Interest 
this concept is utilized on Small term loans, automobile loans etc  Compound Interest concept is used by Banks, Financial institutions on Deposits etc. 
Conclusion
This is an easy and a simple tool for estimation of the interest earned or paid on a given Principal amount for a given time frame, it does not take into consideration the impact of compounding (the process of earning interest on principal plus interest amount earner previously). This can understate the amount of interest earned or paid over time.
Additional Resources
Hope you liked the Simple Interest Guide and also the differences between Simple vs Compound Interest. You may also look at below articles to learn Corporate Finance.
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