Calculating Compound Interest | A Comprehensive Guide to the Future Value of Investments and Loans

compound interest formula

The compound interest formula is used to calculate the future value of an investment or loan that accrues compound interest over a specified time period

The compound interest formula is used to calculate the future value of an investment or loan that accrues compound interest over a specified time period. It takes into account the principal amount, interest rate, compounding frequency, and the duration of the investment.

The general formula for calculating compound interest is:

A = P(1 + r/n)^(nt)

Where:
– A represents the future value of the investment/loan.
– P is the principal amount (the initial amount of money invested or borrowed).
– r is the annual interest rate (expressed as a decimal).
– n is the number of times the interest is compounded per year.
– t is the time (in years) that the money is invested or the loan is held for.

Let’s break down each component of the formula:

1. Principal amount (P): This is the initial amount of money invested or borrowed. It serves as the starting point for calculating compound interest.

2. Annual interest rate (r): The interest rate is expressed as a decimal, not a percentage. For example, if the interest rate is 5%, it would be written as 0.05 in the formula.

3. Compounding frequency (n): This refers to the number of times the interest is compounded in a year. Common compounding periods include annually (n = 1), semi-annually (n = 2), quarterly (n = 4), monthly (n = 12), and daily (n = 365). The more frequently the interest is compounded, the higher the final amount will be.

4. Time (t): The duration of the investment or the loan, usually measured in years. It represents the time that interest accumulates on the principal amount.

By plugging in the appropriate values into the formula, you can calculate the future value (A) of the investment or loan that accrues compound interest over time.

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