Compound interest with monthly compounding
A school invests $8,000 in a reserve account earning 4.8% per annum, compounded monthly. The monthly interest rate is 0.4%.
(a) Calculate the balance after 30 months, correct to the nearest cent.
(b) Immediately after the 30-month balance is calculated, the school withdraws $1,500 and leaves the remainder in the account for a further 18 months at the same rate. Calculate the final balance, correct to the nearest cent.
(c) Explain why using an annual growth factor once per year would not give the same result as the monthly-compounding model.
Reveal worked answer
Worked answer
(a) Monthly multiplier: 1.004. Balance: 8000 x 1.00430 = $9017.82.
(b) Carry the unrounded first balance: (8000 x 1.00430 - 1500) x 1.00418 = $8077.90.
(c) Monthly interest is added before later monthly interest is calculated. An annual factor changes the compounding timing and does not model the withdrawal at the stated monthly stage.
Why this earns credit
The response keeps the monthly rate and number of monthly periods together in each growth factor. It carries the first balance unrounded before applying the withdrawal and second growth period, so the displayed final amount is reproducible. It also explains why the timing of compounding affects the result.
Common errors
- Using 4.8% as the monthly rate or using 30 years instead of 30 months.
- Rounding the first balance to cents and then reporting a final amount that cannot be reproduced from the displayed rounded working.
- Applying 1.048 for each monthly period or applying one annual factor without modelling the withdrawal at the stated monthly stage.