5.1: Principal, Rate, Time
Formula & Symbol Hub
For this section you will need the following:
Symbols Used
Simple Interest Present Value or Principal Interest rate Time period over which interest is charged
Formulas Used
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Formula 5.1 – Simple Interest
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Formula 3.1b – Rate, Portion, and Base
Introduction
Your investments may be at risk if stock and bond markets slump, as a story in the Globe and Mail predicts. You wonder if you should shift your money into relatively secure short-term investments until the market booms again. You consider your high-interest savings account, but realize that only the first
Looking ahead, what income will you live on once you are no longer working? As your career develops, you need to save money to fund your lifestyle in retirement. Some day you will have
To make such decisions, you must first understand how to calculate simple interest. Second, you need to understand the characteristics of the various financial options that use simple interest. Armed with this knowledge, you can make smart financial decisions!
The world of finance calculates interest in two different ways:
- Simple Interest: A simple interest system primarily applies to short-term financial transactions, with a time frame of less than one year. In this system, which is explored in this chapter, interest accrues but does not compound.
- Compound Interest: A compound interest system primarily applies to long-term financial transactions, with a time frame of one year or more. In this system, which the next chapter explores, interest accrues and compounds upon previously earned interest.
Simple Interest
In a simple interest environment, you calculate interest solely on the amount of money at the beginning of the transaction. When the term of the transaction ends, you add the amount of the simple interest to the initial amount. Therefore, throughout the entire transaction the amount of money placed into the account remains unchanged until the term expires. It is only on this date that the amount of money increases. Thus, an investor has more money or a borrower owes more money at the end.
The figure illustrates the concept of simple interest. In this example, assume
A loan or investment always involves two parties—one giving and one receiving. No matter which party you are in the transaction, the amount of interest remains unchanged. The only difference lies in whether you are earning or paying the interest.
- If you take out a personal loan from a bank, the bank gives you the money and you receive the money. In this situation, the bank earns the simple interest and you are being charged simple interest on your loan. In the figure, this means you must pay back not only the
you borrowed initially but an additional in interest. - If you place your money into an investment account at the bank, you have given the money and the bank has received the money. In this situation, you earn the simple interest on your money and the bank pays simple interest to your investment account. In the figure, this means the bank must give you back your initial
at the end plus an additional of interest earned.
The best way to understand how simple interest is calculated is to think of the following relationship:
Notice that the key variables are the amount, the simple interest rate, and time. Formula 5.1 combines these elements into a formula for simple interest.
Simple Interest
In this case, you calculate an annual interest rate in its decimal format as follows:
Thus, if you are earning
HOW TO
Calculate Simple Interest
Follow these steps when you calculate the amount of simple interest:
Step 1: Formula 5.1
Step 2: Ensure that the simple interest rate and the time period are expressed with a common unit. If they are not already, you need to convert one of the two variables to the same units as the other.
Step 3: Apply Formula 5.1
Assume you have
Step 1: Note that your principal is
Step 2: Convert the time period from months to years:
Step 3: According to Formula 5.1:
Therefore, the amount of interest you earn on the
Key Takeaways
Recall that algebraic equations require all terms to be expressed with a common unit. This principle remains true for Formula 5.1
- The time needs to be expressed annually as
of a year to match the yearly interest rate, or - The interest rate needs to be expressed monthly as
per month to match the number of months.
It does not matter which you do so long as you express both interest rate and time in the same unit. If one of these two variables is your algebraic unknown, the unit of the known variable determines the unit of the unknown variable. For example, assume that you are solving Formula 5.1
Paths To Success
Four variables are involved in the simple interest formula, which means that any three can be known, requiring you to solve for the fourth missing variable. To reduce formula clutter, the triangle technique illustrated in the video helps you remember how to rearrange the formula as needed.
Concept Check
Try It
1) Answer the following:
- If you have money in your savings account (or any other investment) and it earns simple interest over a period of time, would you have more or less money in your account in the future?
- If you have a debt for which you haven’t made any payments, yet it is being charged simple interest on the principal, would you owe more or less money in the future?
Solution
- More, because the interest is earned and therefore is added to your savings account.
- More, because you owe the principal and you owe the interest, which increases your total amount owing
Example 5.1.1
Julio borrowed
Solution
Step 1: What are we looking for?
You need to calculate the amount of interest that Julio owes Maria.
Step 2: What do we already know?
The terms of their agreement are as follows:
Step 3: Make substitutions using the information known above.
The rate is annual, and the time is in months. Convert the time to an annual number. Since five months out of

Apply Formula 5.1
Step 4: Provide the information in a worded statement.
For Julio to pay back Maria, he must reimburse her for the
Example 5.1.2
A
Solution
Step 1: What are we looking for?
You need to calculate the annual interest rate (
Step 2: What do we already know?
The principal, interest amount, and time are known:
Step 3: Make substitutions using the information known above.
The computed interest rate needs to be annual, so you must express the time period annually as well. Since six months out of

Apply Formula 5.1
Step 4: Provide the information in a worded statement.
For
Example 5.1.3
What amount of money invested at
Solution
Step 1: What are we looking for?
You need to calculate the amount of money originally invested, which is known as the present value or principal, symbolized by
Step 2: What do we already know?
The interest rate, time, and interest earned are known:
Step 3: Make substitutions using the information known above.
Convert the time from months to an annual basis to match the interest rate. Since eleven months out of
Apply Formula 5.1
Step 4: Provide the information in a worded statement.
To generate
Example 5.1.4
For how many months must
Solution
Step 1: What are we looking for?
You need to calculate the length of time in months (
Step 2: What do we already know?
The amount of money invested, interest earned, and interest rate are known:
Step 3: Make substitutions using the information known above.
Express the time in months. Convert the interest rate to a “per month” format.

Apply Formula 5.1
Step 4: Provide the information in a worded statement.
For
Try It
2) If you want to earn
Solution
Step 1: Given information:
Step 2: Convert monthly
Step 3: Solve for
Step 4: Write as a statement.
I must invest
Try It
3) If you placed
Solution
Step 1: Given information:
Step 2: Convert annual
Step 3: Solve for
Step 4: Write as a statement.
It takes
Try It
4) A
Solution
Step 1: Given information:
Step 2: Convert the time period from months to years:
Step 3: Solve for
Step 4: Write as a statement.
The investment earned
Time and Dates
In the examples of simple interest so far, the time period was given in months. While this is convenient in many situations, financial institutions and organizations calculate interest based on the exact number of days in the transaction, which changes the interest amount.
To illustrate this, assume you had money saved for the entire months of July and August, where
Using The BA 2+ Plus Date Function to Calculate the Exact Number of Days
In the video below we’ll demonstrate how to use the BA2+ Date Function:
Key Takeaways
When solving for
Example 5.1.5
On September 13, 2011, Aladdin decided to pay back the Genie on his loan of
Solution
Step 1: Given variables:
Step 2: The time is in days, but the rate is annual. Convert the rate to a daily rate:
Step 3: Solve for the time,
Step 4: Use the DATE function to calculate the start date (DT1). Use the time in days.
Calculator Instructions:

Step 5: Write as a statement.
If Aladdin owed the Genie
Section 5.1 Exercises
In each of the exercises that follow, try them on your own. Full solutions are available should you get stuck.
- Brynn borrowed
at per month from a family friend to start her entrepreneurial venture on December 2, 2011. If she paid back the loan on June 16, 2012, how much simple interest did she pay?
Solution
Step 1: Given information:
Use DATE function on calculator to get the number of days. Total days for
Step 2: Convert both the monthly
Step 3: Solve for
Step 4: Write as a statement.
She payed
- If
principal plus of simple interest was withdrawn on August 14, 2011, from an investment earning interest, on what day was the money invested?
Solution
Need to calculate
Step 1: Given information:
Step 2: Convert annual
Step 3: Solve for
Use the DATE function on the calculator to find the date when the money was invested.
Step 4: Write as a statement.
The money was invested on March 20, 2011.
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Attribution
“8.1 Simple Interest: Principal, Rate, Time” from Business Math: A Step-by-Step Handbook Abridged by Sanja Krajisnik; Carol Leppinen; and Jelena Loncar-Vines is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.