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Example 2

A person has agreed to lend £1,000 to a friend on 1 January, year 1, over a four-year period to start planting a tree farm. The friend has been promised a 10% compound interest on the investment and will pay it back as and when he can. In the end , the cash flow is shown in the table below. Will the person get their money back? This can be checked by inserting the figures in the equation.

How can the friend check that they have a 10% compound interest? Consider the data, then select the button below to reveal our suggestion:

They could do so by discounting the cash flows as follows:

Over the four years the money was paid out, on 1 January it is paid back as below. In the end, they lose 2p on the deal at 10%.

Years outstandingAmount owed with interestAmount paid backDiscounted at 10% ratePresent value
Years outstanding: year 1 £1,000 £0 1  -£1000
Years outstanding: year 2 £500 £600 0.9091  £545.46
Years outstanding: year 3 £50 £500 0.8264 £413.2
Years outstanding: year 4 £0 £55 0.7513 £41.32

The difference at the end of year 4 would be £0.02