To calculate interest correctly, you need to know three values:
- The principle amount
- The interest rate
- The amount of time (in years or fractions of a year)
When you know these three values, calculating interest is simple.
We’ll call interest (I), principle (P), rate (r), and time (t). Then I = Prt.
Example: On June 1st, an employee borrows $350 from his employer who charges 6% interest as long as it is paid back by the first of the year. How much will the employee owe on January 1st?
Answer: The principle is $350, or P=350. The interest rate is 6%, or r=.06. We need to figure out what t equals since it is not in the form of years. To do this, we need to find out what our fraction of a year is. And to do that, we need to know the number of days of the loan. Let’s just add them up. June = 30, July = 31, August = 31, Sept = 30, Oct = 31, Nov = 30, Dec = 31. So the total days will be 214 and the fraction of the year is (214)/(365).
Our formula, then, looks like this: I = (350)(.06)(214/365) = $12.31
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