Applying the concept of simple and compound interest on practical situations

You may ask, Why do I even need to learn simple/compound interest? All I have to do is not borrow and not lend money! Well, that thinking is very childish! GROW UP! In our life, I bet that we will borrow or lend money, and simple interest is for, well, simple amounts. For example, in primary school you may come across people saying"You lend me $1 I return you $2 tomorrow" This is a perfect and simple example of simple interest. You borrow money at a 100% interest.(Which is very stupid)
Now, compound interest. Its pretty much the same as simple interest, and you can think of compound interest as a series of back-to-back simple interest contracts. The interest earned in each period is added to the principal of the previous period to become the principal for the next period. For example, you borrow $10,000 for three years at 5% annual interest compounded annually:

p = principal (original amount borrowed or loaned)
i = interest rate for one period
n = number of periods

interest year 1 = p x i x n = 10,000 x .05 x 1 = 500(i1)
interest year 2 = (p2 = p1 + i1) x i x n = (10,000 + 500) x .05 x 1 = 525(i2)
interest year 3 = (p3 = p2 + i2) x i x n = (10,500 + 525) x.05 x 1 = 551.25

Total interest earned over the three years = 500 + 525 + 551.25 = 1,576.25. Compare this to 1,500 earned over the same number of years using simple interest. You will find that you earned A LOT of money as compared to charging simple interest.
So there you have it for those aspiring entrepreneurs, charge compound interest for any amount you lend, and you will be rolling in the green stuff if the lender is a procrastinator and takes ages to pay back. Ditto loan sharks
=)


Source: http://www.getobjects.com/Components/Finance/TVM/iy.html