Simple and compound interests have a wide range of differences. The first difference begins at the definition level. Generally, simple interest is often based on the interest that accrues from the loan borrowed or deposited. On the other hand, compound interest earns interest on the previously earned interest in every period. Simple interest is calculated on the initial loan amount that was borrowed (principal). This makes it easy to determine the compound interest of a given loan. On the contrary, compound interest accumulates and is added to the interest of the previous periods. The other difference relates to how simple and compound interest are calculated (Bakir, 2016). Simple interest is calculated by multiplying the amount borrowed by the interest rate per year by the loan term. The formula is expressed as Simple interest=p*r*n. On the other hand, compound interest is arrived at by multiplying the principal by one and adding the yearly interest raised to the sum of compound interests. The results are then subtracted from the reduction in the principal during that year. Basically, compound interest=p*(1+r)t-p (Bakir, 2016).
Present and future values are some of the common that are used in the financial sector. They are primarily used to calculate the future and current net worth associated with a given amount of money. Generally, both present and future values are based on the time value of a given amount of money. One of the primary distinctions between future and present value is that future value refers to the amount of money that will accrue after making consistent investments after a stipulated timeframe. On the other hand, the present value refers to the current value of the total income generated by a given investment in the future. In simple terms, present value is the money that needs to be invested today to generate a specific income in the future.
Considering the time value of money is crucial since it lays a foundation for investors and individuals to make more informed decisions about what they will do with their money. Understanding the time value of money also assists one in gaining insights concerning the best option based on inflation, risk, and interest (Pattavina, 2018). Several considerations, however, need to be embraced when considering the time value of money. They include the number of periods, the current value, the interest rates charged annually, and the future value (Pattavina, 2018).
The above statement about money is true because money is like time. When one has a dollar or borrows a dollar today, its value will not be the same in the future and vice versa. A dollar today is worth more dollars tomorrow because when invested, it can earn and yield more than a dollar in the future.
Bakir, S. T. (2016). Compound Interest Doubling Time Rule: Extensions and Examples from Antiquities. Communications in Mathematical Finance, 5(2). http://www.scienpress.com/Upload/CMF/Vol%205_2_1.pdf
Pattavina, J. (2018). The Time-Value of Money. Lulu. Com.