Tonya J.

# The following formula is incorrect for compound interest with the symbols defined this way, can someone tell me why?

The following formula is incorrect for compound interest with the symbols defined this way, can someone tell me why?

Compound Interest is described by A = P(1+rm)^n, where P is the principal, r is the annual rate, m is the number of compounding periods in 1 year, and A is the amount in the account after n compounding periods.

It is an Exponential function since the exponent is a variable.

## 4 Answers By Expert Tutors

By: Tutor
4.9 (7)

Jeff M, Accounting, Microsoft Excel, Finance, General Business

Tonya J.

This seems right to me but Michael down below there says all answers are wrong but his. Am I missing something?
Report

02/01/14 Jeff M.

No, Tonya, you're not missing anything.  Michael's answer is correct, but his formula is the same as the formula I was driving at. Using your symbols, the formula should be:

A = P * (1 + r/m)^n

So, to correct your original formula, the annual interest rate (r) should be divided by the number of compounding periods (m). Your formula multiplied the two, resulting in an overstatement of A. Using the numbers from my example, this makes sense intuitively - the quarterly interest rate is 1.25% (5%/4), rather than 20% (5% * 4).

If you plug some numbers into this equation and Michael's, you will get the same result.  I've seen many variations of this formula in practice, which is likely the reason your instructor answered the way (s)he did.

Hopefully that makes sense?
Report

02/02/14

Tutor
4.9 (15)

Mathematics Tutor

Tonya J.

Report

02/01/14

Tonya J.

That's what I thought as well but my instructor felt differently. Here is his response to my formula:

"Your formula is incorrect for Compound Interest if you define the symbols the way you did. Look at how the reading defines the symbols."

I can't figure out what he means, any ideas?
Report

02/01/14 Michael F.

tutor
A = P * ((1 + (.05 / 4))^8)
very truly yours
Michael F.
Report

02/01/14 Tutor
4.4 (10)

Experienced scientist, mathematician and instructor - William

## Still looking for help? Get the right answer, fast.

Get a free answer to a quick problem.
Most questions answered within 4 hours.

#### OR

Choose an expert and meet online. No packages or subscriptions, pay only for the time you need.