Interest earned, calculating

When you borrow money, you pay additional funds for the service. When you deposit money into savings you earn additional funds for your deposit. In either case, the additional funds are called interest. The money borrowed or deposited is called principal the percentage used to calculate the additional funds is called the interest rate. Interest earned or owed is dependent not only on the principal and rate, but also on another variable, which is the length of time in years. To calculate interest for one year, you can set up a proportion. Because interest is such a common occurrence in the business world, there is a formula used to calculate interest / = PRT. The interest is I, P is the principal, R is the rate written as a decimal, and T is the time in years. 

Discounted cashflow rate of return (DCFRR). This method is called the investors return on investment, internal rate of return, profitability index, interest rate of return, or discounted cashflow. A trial-and-error solution is necessary to calculate the average rate of interest earned on the company s outstanding investment in the project. It can also be considered the maximum interest rate at which funds could be borrowed for investment in the project, with the project breaking even at the end of its expected life. 

When calculating compound interest, it is easiest to sequentially calculate the interest earned using I = PRT. You should be familiar with the following ways of compounding interest ... 

The times-interest-earned ratio is a measure of the extent to which profits could decline before a company is unable to pay interest charges. This ratio is calculated by dividing the earnings before interest and taxes (EBIT) by the interest charges. 

The total interest earned during the eight-year life of this account is determined by calculating the dififtrence between the future value and the present deposit value. 

The market convention is to quote annualized interest rates the rate corresponding to the amount of interest that would be earned if the investment term were one year. Consider a three-month deposit of 100 in a bank earning a rate of 6 percent a year. The annual interest gain would be 6. The interest earned for the ninety days of the deposit is proportional to that gain, as calculated below ... 

A bond s yield to maturity will understate (or overstate) the realized compounded yield when the true reinvestment rate is greater than (or less than) the calculated yield to maturity. Figure A4-6 illustrates this relationship for a 10 percent coupon bond that pays 30 in interest every 6 months, has 10 years until it matures, and is originally priced to sell at par (that is, its yield to maturity is equal to the coupon rate). If the annual reinvestment rate is also 10 percent (5 percent per 6-month period), the terminal value of the cash flows received plus the interest earned from the reinvestment of those cash flows will be equal to 2,653.30 1,000 from the maturity value of the bond, 1,000 to be received in the form of coupon payments, and 653.30 from reinvesting the coupons every 6 months to earn a 5 percent, 6-month rate. Given the starting value of 1,000 and the terminal value of 2,653.30, the terminal value ratio is equal to... 

Some companies feel they should earn interest on their equity as w ell as get a payout. To calculate this, the cash flows are discounted back to year 0 using some arbitrary interest (discount) rate, then the positive discounted cash flows are summed each year of operation until they equal the sum of the discounted negative cash flows. This yardstick also works but consistency must be maintained from one project to another. The discount (interest) rate and payout both become variables that must be set and perhaps changed from time to time depending on economic conditions inside and outside the company. 

Discounted cash-flow analysis, used to calculate the present worth of future earnings (Section 6.10.3), is sensitive to the interest rate assumed. By calculating the NPW for various interest rates, it is possible to find an interest rate at which the cumulative net present worth at the end of the project is zero. This particular rate is called the discounted cash-flow rate of return (DCFRR) and is a measure of the maximum rate that the project could pay and still break even by the end of the project life. 

Both methods assume that the money earned can be reinvested at the nominal interest rate. Suppose the rates of return calculated are after tax returns and the company is generally earning a 5% or 6% return on investment. Is it reasonable to expect that all profits can be reinvested at 23% or even 20% No, it isn t Yet this is what is assumed in the Rate of Return method. Sometimes the rate of return may be as high as 50%, while a reasonable interest rate is less than 15%. Therefore if a reasonable value for the interest rate has been chosen (this is discussed later in this chapter) and the two methods differ, the results indicated by the Net Present Value method should be accepted. 

A plant costs 14,000,000 and has a salvage value of 2,000,000 and a net salvage value of 1,000,000. The expected life of the plant is 8 years. Calculate the present value for the depreciation plans presented in this chapter. Assume that the interest rate is 10% and the income tax rate is 48% of all earnings. 

The EVA [10,11] combines information from the profit and loss statement (revenue, costs, earnings before interests and taxes (EBIT), etc.) and the financial sheet (net working capital (NWC), assets, etc.). The EVA is the interest calculation in absolute measurements and strongly related to the return on capital employed (ROCE) where the gained interest rate is calculated (Figure 1.7). In the long term, this interest rate should be above the capital costs of the company which is the interest rate the company has to pay for a credit on the capital market. Hence, a positive EVA means that the company has earned some money above the capital costs. 

Once it has been established that you may set up an individual retirement account, you must consider the maximum amount of contributions which can be made under this type of plan. The contribution limitations are 1500 or 15% of your earned income, whichever is less. For these type of plans, earned income is defined as wages, salaries, professional fees, and self-employment income. It does not, however, include earnings from property, such as interest, dividends, or rents. These latter types of earnings are considered passive income and cannot be considered in calculating the amount of contribution which may be made. 

EARN distributions the yield along the azimuth 4>= —30° was preferentially reduced with respect to = + 30°. In agreement with intuition, the calculations confirm that the oxygen atom resides in the C-site. Thus from the cooperation of EARN experiments and computer simulations the coverage and nature of the adsorption site of 0/Rh(l 11) has been determined. It will be of interest to see if other surface structure techniques can be used to confirm these s Kcific surface structures. 

When the NPW is calculated according to Eq. (9-21), if the result is positive, the venture will earn more than the interest (discount) rate used conversely, if the NPW is negative, the venture earns less than that rate. 

The Internal Rate of Return (IRR) is the equivalent interest rate at which the Net Present Value of the acquisition would be zero. Given the projected total cost of the system, and the projected total benefits of the system, both projected back (discounted) to today, it is the interest rate that the investment could sustain and still just break even. Since firms, in general, operate at a point where their incremental cost of money is equal to its incremental earning power, any investment that returns an IRR better than the cost of money is a good investment. Traditionally, the IRR is found by calculating the NPV with different interest factors in a trial and error method until the interest factor is found which drives the NPV to approximately zero. 

It is necessary to use a trial-and-error solution to calculate the discounted cashflow rate of return, because the interest rate must be determined that will make the present value at the startup time of all earnings equal to that of all investments. An example of a typical balance for continuous-income and continuous-interest with uniform annual net income follows. 

In this calculation, the interest rate will be negative if inflation is working (i.e. P > F), or positive for an investment where interest is being earned (i.e. F > P). 

It is worth noting that the calculated total cost of production is greater than the projected annual revenue of 560 MM/y. This suggests that the project would not earn the expected 15% interest rate. This is explored further in the following example and in problems 6.14 and 6.15. 

A plant manager must often decide if it is truly worthwhile to invest in new equipment. The fundamental question is, Will the company earn more money per year by investing in this equipment than it would if the money was invested in an interest-bearing financial account The calculation that is used to make this decision is called the percent rate of return on investment (ROI) and is carried out as follows ... 

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