When the money consequences of an alternative occur in a short period of time say, less than one year we might simply add up the various sums of money and obtain the net result. But we cannot treat money this same way over longer periods of time. This is because money today does not have the same value as money at some future time.

Consider this question: Which would you prefer, $100 today or the assurance of receiving $100 a year from now? Clearly, you would prefer the $100 today. If you had the money today, rather than a year from now, you could use it for the year. And if you had no use for it, you could lend it to someone who would pay interest for the privilege of using your money for the year.

Simple Interest

Simple interest is interest that is computed on the original sum. Thus if one were to lend a present sum P to someone at a simple annual interest rate i, the future amount F due at the end of n years would be

Example 2

How much will you receive back from a $500 loan to a friend for three years at 10% simple annual interest?

Solution

In Example 2 one observes that the amount owed, based on 10% simple interest at the end of one year, is 500 + 500 0.10 1 = $550. But at simple interest there is no...