The year-by-year values of amount of interest and the total amount owed (as shown in Table 1.2) are calculated as follows;
Amount of interest accrumulated at the end of Year 1 = Rs. 10,000 X 0.08 = Rs. 800
Total amount owed at the end of Year 1 = Rs. 10,000 + Rs. 800 = Rs. 10,800
Amount of interest accumulated at the end of Year 2 = Rs. 10,800 X 0.08 = Rs. 864
Total amount owed at the end of Year 2 = Rs. 10,800 + Rs. 864 = Rs. 11,664
Similarly the interest amount and the total amount owed at the end of year 3, year 4 and year 5 can be calculated in the same manner.
From these calculations it is clear that, in case of compound interest the interest for each year is calculated on the principal amount plus the interest amount accumulated till that period.
The total amount owed at the end of each year using compound interest is also graphically shown in Fig. 1.2.
Fig. 1.2 Total amount owed (using compound interest)
The accrued interest at the end of each year considering both simple and compound interest is also shown in Fig. 1.3.
From Fig. 1.3, one can see that in case of simple interest, the amount of interest accumulated each year is constant. However in case of compound interest, the interest amount accumulated at the end of each year is not constant and increases with interest period as evident from Fig. 1.3. Thus considering compound interest, the total amount to be repaid at the end of year 5 is Rs. 14,693.28, which is greater as compared to Rs.14,000 that is to be repaid on the basis of simple interest.
Fig. 1.3 Accumulated interest at the end of each year