208 Energy Project Financing: Resources and Strategies for Success
described as a decrease in the purchasing power of money. The impact
of inflation is that the “basket of goods” a consumer can buy today with
$100 contains more than the “basket” the consumer could buy one year
from today. This decrease in purchasing power is the result of inflation.
The subject of inflation is addressed in Section A.9.4.A.6.2 The Mathematics of Interest
The mathematics of interest must account for the amount and tim-
ing of cash flows. The basic formula for studying and understanding in-
terest calculations is:
Fn = P + Inwhere: Fn = a future amount of money at the end of the nth yearP = a present amount of money at the beginning of the year
which is n years prior to FnIn = the amount of accumulated interest over n yearsn = the number of years between P and FThe goal of studying the mathematics of interest is to develop a for-
mula for Fn that is expressed only in terms of the present amount P, the
annual interest rate i, and the number of years n. There are two major ap-
proaches for determining the value of In: simple interest and compound
interest. Under simple interest, interest is earned (charged) only on the
original amount loaned (borrowed). Under compound interest, interest
is earned (charged) on the original amount loaned (borrowed) plus any
interest accumulated from previous periods.A.6.3 Simple Interest
For simple interest, interest is earned (charged) only on the original
principal amount at the rate of i% per year (expressed as i%/yr). Table A-
4 illustrates the annual calculation of simple interest. In Table A-4 and the
formulas which follow, the interest rate i is to be expressed as a decimal
amount (e.g., 8% interest is expressed as 0.08).
At the beginning of year 1 (end of year 0), P dollars (e.g., $100) are
deposited in an account earning i%/yr (e.g., 8%/yr or 0.08) simple inter-
est. Under simple compounding, during year 1 the P dollars ($100) earn