A company is considering to start a new product line. The new product line requires the installation of new machines and equipment. For this purpose, company wants to borrow money by issuing bonds of $10,000 for 12-year period. The interest on these bonds is to be paid at a rate of 8% per year.
Compute the amount of interest to be paid to bondholders over 12-year period:
- if the simple interest is charged.
- if the interest is compounded annually.
(1) If interest is simple:
I = Pin
= $10,000 × 8% × 12
= $10,000 × 0.08 × 12
(2) If interest is compounded annually:
To compute compound interest for 12-year period, we would compute compound amount first using compound amount formula and then compute compound interest by deducting the principal amount from compound amount.
S = P(1 + i)n
= $10,000 × (1 + 8%)12
=$10,000 × 2.518*
Interest to be earned over 8-year period: $25,180 – $10,000 = $15,180
*Value of (1 + 8%)12 from future value of $1 table: 12 periods; 8% interest rate.