Chapter 11
Compound Interest and Present Value
Student Performance Objectives:
Section I Compound Interest – The Time Value of Money
11-1 Manually Calculating Compound Amount (Future Value) and Compound Interest
11-2 Computing Compound Amount (Future Value) and Compound Interest By Using
Compound Interest Tables
Section II Present Value
11-6 Calculating the Present Value of a Future Amount Using Present Value Tables
Chapter Notes, Teaching Tips and Lecture Launchers
• Lecture Launcher: How do you make a baby a millionaire? Put $1,000 into an account
• Lecture Launcher: Benjamin Franklin understood the value of compounding. In his will, he
left a bequest to the cities of Philadelphia and Boston of £1,000 each, approximately $4,444,
• Spotlight: Use Exhibit 11-1, The Time Value of Money, to illustrate the dramatic difference
between simple and compound interest.
• For easy reference, remind students that all of the formulas used in this chapter are listed in a
Summary Chart.
• Spotlight: This Business Decision, “Pay Me Now, Pay Me Later” at the end of the chapter,
provides students with a realistic example of how the “time value of money” is used in
business.
• Students who solve this exercise have achieved a good working knowledge of this
Section I Compound Interest – The Time Value of Money
• Spotlight: Explain to students that compound interest is nothing more than the simple
interest formula, I = PRT, applied a number of times, with each time the interest added to the
previous principal.
• Point out that manual calculation of compound interest is very tedious. A ten-year
• To illustrate the Time Value of Money Concept and inflation, ask students to estimate the
cost of a house or a vehicle 10, 20 or 30 years ago, compared with the present. You might
also ask them to predict how much these assets might cost in the next 10, 20, or 30 years.
• Lecture Launcher: Ask students how much annual income is required for the standard of
living they (realistically) wish to have. Then have them calculate how much annual income
they’ll need at retirement to have the same standard of living, assuming 3%-4% inflation.
• Demonstrate to students that effective rate is not affected by the amount of principal
invested. Essentially, the effective rate is the table factor minus 1, regardless of the principal.
• Spotlight: To prove this point, have students calculate the effective rate for $5,000
and $10,000 at 12% compounded monthly. (Note, they are the same, 12.68%)
• Spotlight: In creating new table values, students sometimes mistakenly add the values, rather
than multiply.
• Be sure they understand, they must “multiply” two values whose periods “add up” to
• Discuss with students the concept of Annual Percentage Yield, (APY).
• Homework Assignment: Have students research the current provisions of the Truth
in Lending and Truth in Savings laws and report their findings to the class.
• Classroom Activity: Have students bring examples of advertisements from the local paper
• Classroom Activity: Ask students to research the current CD rates and offerings from local
financial institutions. Also, have them look into the advantages of purchasing multiple CDs;
such as two $4,000 CDs instead of one $8,000 CD, or even eight $1,000 CDs.
• Collaborative Learning Activity: Have students break into groups to write and work some
Section II Present Value
• Spotlight: In solving compound amount and present value word problems, students
• Students notoriously get confused as to which table should be used to calculate future value
and present value.
• Spotlight: Use Exhibit 11-2, Present Value and Future Value at Compound Interest,
to illustrate that when present value is known, the future value will be a larger number
• Demonstrate the relationship between Tables 11-1 and 11-2 by introducing the concept of
reciprocals. Point out that each table factor, at a given rate and period, is the reciprocal of the
other table factor.
• Collaborative Learning Activity: Have students break into groups to write and solve some
word problems involving compound interest and present value. Next, have each group work
the problems of another group, compare answers and resolve differences.
Questions Students Always Ask
“Why do I multiply the number of years by the compounding periods per year, but divide the
interest rate by the number of compounding periods per year?”
• It is quite helpful, especially for visual learners, to draw a timeline of three or so
years. Write the annual interest rate, e.g. 12%, above the segment for each year.
“How do I know which table to use?”
• Again, draw a timeline with “Present” on the left end and “Future” on the right. Put a
dollar sign under “Present” and a question mark under “Future”. This indicates that if I
“Why do I multiply the factor by the principal?”
• The Compound Interest table shows how much $1 will be worth a certain number of
“How can I tell if I used the right table?”
• Remember, present value is always less than future value. Look at your result and ask