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Suppose you invest $2,500 in a fund earning 10% simple interest annually. After two years you have the option of moving your money to an account that pays compound interest at an annual effective rate of 7%. Should you move your money to the compound interest account (a) if you wish to liquidate in five more years?(b) if you are confident your money will stay on deposit for a total of ten years?

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Answer:

account after 2 years of simple interest at 10%: (2,500 * 0.10 * 2) + 2500 = 3,000  

Note that simple interest only pays interest on the original balance, NOT on the accrued (paid) interest....

a) 5 more years at 10% simple: (2500 * 0.10 * 5) + 3,000 = $4,250

or

5 years compound interest on $3k: 3,000(1.07^5) = $4,207.66

b) TOTAL of 10 years

simple interest: (2500 * 0.10 * 10) + 2500 = 5,000

compound interest: only 8 years remain of the total 10 year time horizon

3000(1.07^8) = $5,154.56

Step-by-step explanation:

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