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Installments in Compound Interest

Do you know, If someone wants to buy a Motor Cycle, or a costly mobile or if your father wants to
purchase a new flat, they generally take loan from a bank or from a nancier. They need to pay
monthly installments. Today, across the world, all the EMI's (Equated monthly Installments) are being
calculated on compound interest. So after reading this article, you must be in a position to calculate
the EMI you are going to pay for your new scooter purchase!!

Before that, let us try to understand the meaning of compounding and discounting. We know that daily
prices of the goods increase at a rate. Assume, A product which costs Rs.100 costs Rs.110 next year
and Rs.121 that next year. Suppose, You lend Rs.100 to your friend and he promised to give you
Rs.100 after 1 year. Do you accept it? Out of friendship we accept. But think like a nancier. If you
receive Rs.100 after 1 year the value of this 100 rupee may not buy the same amount of goods it would
have purchased today as the prices went up to Rs.100. So we need to charge some interest. So how
much is the interest?
We use the formula of compound interest.
R R
P (1 + ) = A 100 (1 + ) = 110
100 100

It is clear that interest rate is 10%

That means, if the interest rate is 10%, Rs.100 today is equal to Rs.110 earned after 1 year and Rs.121
after 2 years.

Formula for installments in Compound Interest:

If a buyer sells a product to you at full payment get some interest on your amount for n periods. This
total amount should equal to sum of all EMI's and the interests accrued on each EMI for the remaining
period. Then only the seller did not get any loss.
Assume we have taken a loan at period 0 and have to pay installments at the end of 1, 2, 3, 4th periods
of x each.
Now loan amount plus the interest on the total loan amount P at R% rate for 4 periods is equal to all
the EMI's and interests earned for the remaining period. That is the EMI in the period 2 earns 2 periods
interest and EMI in the 3rd period earns only 1 period interest.
4 3 2 1
R R R R
P (1 + ) = x(1 + ) + x(1 + ) + x(1 + ) + x
100 100 100 100

Present Value method:

We should also solve this problem by Present Value (PV method). You learn this concept in any
nance text book!!
We already learnt that Rs.110 earned after 1 year is equal to Rs.100 earned today if the interest rate is
10%
So Rs.110 discounted at 10% gives you Rs.100. Don't worry how to do this. This is quite simple. You
have to calculate P from the compound interest formula.
A
P = n
R
(1 + )
100

Here A = Rs.110, R = 10%, n = 1.

From the above diagram, if we have taken loan for 4 periods, the last installment should discount for 4
periods and so on.
x x x x
 x x x x
So P = 1
+ 2
+ 3
+ 4
R R R R
(1 + ) (1 + ) (1 + ) (1 + )
100 100 100 100

Solved Examples

1. A person borrowed a sum of Rs 6000 at 10% p.a., interest compounded annually. If the money is to
be repaid in three equal annual installment, each payable at the end of the year, then what is the value
of each installment?
a. Rs. 2,000
b. Rs 2,413
c. Rs 2,314
d. Rs 2,662
Answer: b
Explanation:
Sum borrowed = Rs 6000
Interest = 10% at compounded annually and time = 3 years
Let x be the amount paid at the end of each of the 3 years.
3 2
10 10 10
6000(1 + ) = x(1 + ) + x (1 + ) + x
100 100 100

3
6000(1.1) = 1.21x + 1.1x + x

6000(1.331)
x = = 2412.68
3.31

So Installment amount is Rs.2413

2. Three equal installment, each of Rs 200, were paid at the end of year on a sum borrowed at 20%
compound interest compounded annually. Find the sum.
a. Rs 600
b. Rs 400
c. Rs 421.30
d. Rs 432.10
Answer: c
Explanation:
Installments each of Rs 200 for 3 years.
3 2
20 20 20 20
x(1 + ) = 200(1 + ) + 200 (1 + ) + 200 (1 + )
100 100 100 100

3
x(1.2) = 200(1.44) + 200(1.2) + 200

x(1.718) = 200(3.64)

200(3.64)
 200(3.64)
x = = 421.3
1.718

Alternate Method:
we use discounting method. We discount the installments for the present value.
200 200 200
P =
1
+ 2
+ 3
20 20 20
(1 + ) (1 + ) (1 + )
100 100 100

200 200 200

P = + +
1.2 1.44 1.718

P = 421.3

3. A man borrows a certain sum of money and pays it back in 2 years in two equal installments. If C.I.
is reckoned at 5% per annum and he pays back annually Rs. 441, what sum did he borrow?
a. Rs. 820
b. Rs. 800
c. Rs. 882
d. Rs. 850
Answer: a
Explanation:
441 20
Money borrowed which becomes Rs. 441 after one year = =441 ( ) = 420
5 21
(1 + )
100
2
441 20
Money borrowed which become Rs. 441 after two years = = 441 ( ) = 400
5 21
(1 + )
100

Total money borrowed = Rs. 820.

4. A man borrows Rs. 2100 and undertakes to pay back with compound interest @ 10% p.a. in 2 equal
yearly installments at the end of rst and second year. What is the amount of each installment?
a. 1200
b. 1210
c. 1300
d. 1310
Answer: b
Explanation:
Let the installment be x.
x 10x
The value of rst installment before 1 year = =
10 11
(1 + )
100

100x
 x 100x
The value of second installment before 2 years = 2
=
10 121
(1 + )
100

The sum of the above values should equal to principal.

10x 100x
+ = 2100
11 121
110x + 100x
= 2100
121
210x
= 2100
121

x = 1210

Alternative method:
The value of the principal after 2 years = The value of 1st installment after 1 year+ the value of 2nd
installment.
2
10 10

2100(1 + ) =x (1 + ) + x
100 100

121 11
2100 ( ) = x( ) + x
100 10

121 21x
2100 ( ) =
100 10

x = 1210

Alternative method:
1 11
Here, (1 + r) = 1 + =
10 10
10
Ratio of principals of two installments = 1 : = 11 : 10
11

Sum of ratios = 11 + 10 = 21
11
Therefore, Principal of rst instalment = 2100 = Rs. 1100
21

Therefore, Instalment = Principal of rst instalment (1 + r)

11
= 1100 = Rs. 1210
10

5. A man borrows Rs. 820 and undertakes to pay back with compound interest @ 5% p.a. in 2 equal
yearly installments at the end of rst and second year. What is the amount of each installment?
a. 400
b. 420
c. 441
d. 410
Answer: c
Explanation:
The value of 820 after two years = The value of the installment after 1 year+ The value of second
installment
2
5 5
820(1 + ) =x (1 + ) + x
100 100

441 21
820 = x + x
400 20

441 41
820 ( ) = x
400 20

x = 441

Alternative Method:
1 21
Here, (1 + r) = 1 + =
20 20
20
Ratio of principals of two instalments = 1 : = 21 : 20
21

Sum of ratios = 21 + 20 = 41
21
Therefore, Principal of rst installment = 820 = Rs. 420
41
21
Therefore, Installment = Principal of rst installment (1 + r) = 420 = Rs. 441
20

6. A man borrows Rs. 1820 and undertakes to pay back with compound interest @ 20% p.a. in 3 equal
yearly installments at the end of rst, second and third years. What is the amount of each installment?
a. 864
b. 850
c. 820
d. 900
Answer: a
Explanation:
The value of 1820 after three years = The value of the rst installment after 2 years + The value of
second installment after 1 year+ the value of the third installment
3 2
20 20 20
1820(1 + ) =x(1 + ) + x (1 + ) + x
100 100 100

216 36 6
1820 ( ) =x ( ) + x( ) + x
125 25 5

216 36 + 30 + 25
1820 ( ) =x ( )
125 25

216 91
1820 ( ) = x( )
125 25

x = 864
Alternative Method:
1 6
Here, (1 + r) = 1 + =
5 5
2
5 5
Ratio of principals for three years = 1 : : ( )
6 6

= 6 : 6 5 : 5 (On multiplying each ratio by 6 )

2 2 2

= 36 : 30 : 25
Sum of the ratios = 36 + 30 + 25 = 91
36
Therefore, Principal of rst installment = 1820 = Rs. 720
91
6
Therefore, Installment = Principal of rst installment (1 + r) = 720 = Rs. 864
5

General Discussion On EMI's:

Suppose you have taken a loan of Rs.100000 to buy a house at 12% rate to be paid EMI's for 60
months.
n
P r (1 + r)
They use this formula EMI = n
(1 + r) 1

Here r = Rate / 1200

n = periods (5 years = 60 periods)

Sample Loan Schedule:

CarWale EMI Schedule
Following Schedule Is For :100000to repay in60 months.
All calculations are based on EMI in Arrears(i.e. Rear Ended EMI's).
EMI Number EMI Amount Interest Amount Principal Reduction Balance Due
1. Rs.2224 Rs.1000 Rs.1224 Rs.98776
2. Rs.2224 Rs.988 Rs.1237 Rs.97539
3. Rs.2224 Rs.975 Rs.1249 Rs.96290
4. Rs.2224 Rs.963 Rs.1262 Rs.95028
5. Rs.2224 Rs.950 Rs.1274 Rs.93754

Monthly interest is 1% per month. Now after 1 month, interest accrued is 1000. Of the total EMI of
Rs.2224, Rs.1000 used for interest and the remaining Rs.1224 for principal reduction. Now Balance of
Rs.98776 becomes the principal for next month. So interest is 987.7 or Rs.988.
 Aptitude

16 Comments Campusgate
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Ananya

a month ago
a person take a lone of rs 6000 for 3 years at 5 per annum CI. he repaid 2100 in each of 1st 2 years. the
amount he should pay at the end of 3rd year to clear all his debt is
1. 2425.50
2. 2552.50
3. 2635.50
4. 2745.50
Reply

Ramakrishna Salagrama > Ananya

a month ago

Amount to be paid at the end of the rst year = 6000*1.05 = 6300

Installment paid = 2100.
Remaining amount = 6300 - 2100 = 4200
Amount to be paid at the end of second year = 4200*1.05 = 4410
Installment paid = 2100
Remaining amount = 4410 - 2100 = 2310
Therefore, Amount to be paid at the end of third year = 2310*1.05 = 2425.50
Reply

Ananya > Ramakrishna Salagrama

a month ago

thanks
Reply

Ranjan
2 months ago

An amount of Rs. 12820 due 3 years hence, is fully repaid in three annual instalments starting after 1
year.The rst instalments is half of the second instalment and second instalment is two third of the third
year.The rst instalments is half of the second instalment and second instalment is two third of the third
instalment. If the rate of interset is 10 % per annum compounded annually. Find the rst instalment?
1. 2000
2. 4000
3. 5000
4. 6000
5. 6500
Reply

Ramakrishna Salagrama > Ranjan

a month ago

Let the third installment is 300x, then second installment = 200x, and rst one is 100x
Amount due after 1 year = 12820*1.1 = 14102
Principal after 1 year = 14102 - 100x
Amount due after 2 years = (14102 - 100x)*1.1 = 15512.2 - 110x
Principal after 2 years = 15512.2 - 110x - 200x = 15512.2 - 310x
Amount after 3 years = (15512.2 - 310x)*1.1 = 17063.42 - 341x
But this amount is cleared with third installment.
So, 17063.42 - 341x = 300x
Solving, x = 26.62
Therefore, First installment = 26.62*100 = 2662
Reply

Anubhab
2 years ago

S.I. and C.I. for 2 years are 800 and 820 respectively. What are Principal and rate?
Reply

jagadeesh > Anubhab

a year ago

Principal is 8000 and rate of interest is 5%...........

diff b/w ci and si is P(R/100)^2
simple interest is = P*N*R / 100 there n= 2
substitute values we got PR^2 = 200000
and PR = 4000
divide both we got R = 5%
Reply

Vijay Manuwada OU

2 years ago

sir please say me where to buy your book

Reply

gautam verma

2 years ago
What annual installment will discharge a debt of Rs 2,360 due in four years at 12% p.a.
What annual installment will discharge a debt of Rs 2,360 due in four years at 12% p.a.
(a) simple interest ?
(b) Compound Interest?

Please answer this problem.

The answer for part (a) is there in your website. So I need the solution for part
(b) only
Reply

Shubham Patni > gautam verma

9 months ago

The answer for part (a) is 740

The answer for part (b) is 777.
Reply

gautam verma > Shubham Patni

9 months ago

Could you please explain the steps you have followed to reach the answer.
Reply

Shubham Patni > gautam verma

9 months ago

Please nd the solutions for the problem in the photos uploaded.

View uploads.disquscdn.com View uploads.disquscdn.com

Reply

Ramakrishna Salagrama > gautam verma

2 years ago

Here Debt means which includes interest also. As the interest in Si and Ci cases are different, this
question can be solved in only Simple Interest case as the total debt is given.
Reply

gautam verma > Ramakrishna Salagrama

2 years ago
I have solved the problem as below:
Let the instalment be Rs x.
2360 = x + x(1+12/100) + x(1+12/100)^2 + x(1+12/100)^3

Am I solving it correctly? Because my answer differs from that of the author of a book.
Reply

Ramakrishna Salagrama > gautam verma

2 years ago

Send the question and solution to srk7774@gmail.com and I will see if there is any mistake
Reply
 Vinod Saini > Ramakrishna Salagrama

10 days ago
Question 4: Mr. Jack would like to have Rs. 5,00,000 in 6 years for a down payment of a new house.
How much should he deposit each month into savings account paying 6% interest compounded
monthly?
Reply

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