Definition of Compound Interest Example
There are ample examples of compound interest. The following different compound interest example gives an understanding of the most common type of situations where the compound interest is calculated and how one can calculate the same. As there are multiple areas and situations where the compound interest can be calculated, it is not possible to provide all the types of examples. So, some of the examples of compound interest are given below, showing the different situations.
Examples of Compound Interest (With Excel Template)
Let’s take an example to understand the calculation of Compound Interest in a better manner.
Compound Interest Example -1
Harry wants to start the savings out of the money earned by him. He then decides to deposit the initial amount of $ 10,000 into the high-interest savings account. The rate of interest, in this case, will be 15 % per annum compounded yearly. Currently, the age of harry is 40 years, and he plans to take retirement at the age of 60 years. This means that Harry has a time horizon of 40-year over he can accumulate the interest. Calculate the amount of money that Harry is going to receive at the age of 60 years. Also, prepare the table to show the yearly interest and Account value.
Using the information given, the calculation of the compound interest and the amount to be received at the age of 60 years is as below:
Calculation of the Future Value of Investment using Compound Interest Formula is as below:
A = P (1 + r / n) nt
- A = $ 10,000 (1 + 0.15 / 1) 1*20
- A = $ 10,000 (1 + 0.15) 20
- A = $ 10,000 (1.15) 20
- A = $ 10,000 * 16.367
- A = $ 163,665.37
Table to show the yearly interest and Account value
Here Interest is Calculated as:
- Interest = Initial Amount of Investment * Interest Rate (r)
- Interest = 10000*15%
- Interest = $1500
Similarly, for all Years.
and the Account Value is Calculate as:
- Account Value = Initial Amount of Investment + Interest
- Account Value = 10000 + 1500
- Account Value = $11500
Similarly for all Years.
In the present example, we can see that the account value of the investment made initially of $ 10,000 becomes $ 163,665.37 at the end of the 20 year period. This highlights the power of compounding, as with the help of compound interest, harry multiplied his money to many folds without managing the investment actively. Here the Harry was able to earn the interest on the previously earned interest as well.
Compound Interest Example -2
Sam makes an initial investment of $ 10,000 for a period of 5 years. He wants to know the amount of investment which he will get after the 5 years if the investment earns a return of 6 % per annum compounded weekly.
Using the information given, the calculation of the compound interest and the amount to be received after the period of 5 years is as below:
Calculation of the future value of an investment using compound interest formula is as below:
A = P (1 + r / n) nt
A = $ 10,000 (1 + 0.6 / 52) 52*5
A = $ 10,000 (1 + 0.00115) 260
A = $ 10,000 (1.00115) 260
A = $ 10,000 * 1.3496
A = $ 13,496.25
In the present example, we can see that the account value of the investment made initially of $ 10,000 becomes $ 13,496.25 at the end of the 5 year period when the compounding is done on a weekly basis. The compounding increases the value of the investment at the end of the period as interest is earned on the previously earned interest as well. Here the compounding is done 52 times as there are 52 weeks in a year.
Conclusion – Compound Interest Example
The compound interest gives more interest as compared to simple interest as it is derived by charging interest on outstanding principal including interest, unlike simple interest where interest is charged on the original principal amount and no interest over interest is charged. The power of compounding helps in growing the investment with more speed having the features of the exponential function. It is the result of the fact that despite paying off the investment, they are reinvested to grow faster. This is very often used in normal business practices, be it the case of loan or deposit. Moreover, how frequently the compounding is done will also be a deciding factor for growth. Suppose if at any given rate the compounding frequency is per month, then its annualized rate will be more than that of compounding frequency semi-annually or annually.
This has been a guide to the Compound Interest Example. Here we discuss how to calculate compound interest using its formula along with practical examples. You may also have a look at the following articles to learn more –