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Antonello

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1

Estimate compounding

Hi,

In one part of the interview, this is a solution:

The interviewee should be able to estimate the fact that $100*(1 + 20%)^5 is something like $250 off the cuff. Without compounding, it’s obviously $200 exactly, so the answer “something a bit more than $200” is good. Many people answer $200 exactly and, when prompted “is it more or less than $200” choose “less”, which is clearly madness.

Three questions:

1) How should I be able to estimate that this is 250$?

2) If I estimate in that the worth in 5 years will be 100$ + 5*20%(100$), how should I know if it the number should be higher or lower than 200$?

3) In this case, would you do the whole math or simplify it?

Hi,

In one part of the interview, this is a solution:

The interviewee should be able to estimate the fact that $100*(1 + 20%)^5 is something like $250 off the cuff. Without compounding, it’s obviously $200 exactly, so the answer “something a bit more than $200” is good. Many people answer $200 exactly and, when prompted “is it more or less than $200” choose “less”, which is clearly madness.

Three questions:

1) How should I be able to estimate that this is 250$?

2) If I estimate in that the worth in 5 years will be 100$ + 5*20%(100$), how should I know if it the number should be higher or lower than 200$?

3) In this case, would you do the whole math or simplify it?

1 answer

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As quick answer, of course, is great "something a bit more than $200, we can assume $250" (you can say here $240, $230 or anything higher than 200 but lower than 300, use common sense).

No interviewer will ever ask you the exact number, but with a few seconds more you can really crack it. The most relevant addends in the whole compound interest formula (1+p)^n are the first three:

  • 1
  • n*p
  • n*(n-1)/2 * p^2

Therefore in our problem we have: 1 + 5*0.2 + 5*4/2 * 0.2^2 = 1 + 1 + 0.4 = 2.4 -> $240

After a little practice, you will find this formula very easy and immediate, but you will impress every interviewer you are going to face with.

Try it in similar problems and let me know :)

Best,

Antonello

As quick answer, of course, is great "something a bit more than $200, we can assume $250" (you can say here $240, $230 or anything higher than 200 but lower than 300, use common sense).

No interviewer will ever ask you the exact number, but with a few seconds more you can really crack it. The most relevant addends in the whole compound interest formula (1+p)^n are the first three:

  • 1
  • n*p
  • n*(n-1)/2 * p^2

Therefore in our problem we have: 1 + 5*0.2 + 5*4/2 * 0.2^2 = 1 + 1 + 0.4 = 2.4 -> $240

After a little practice, you will find this formula very easy and immediate, but you will impress every interviewer you are going to face with.

Try it in similar problems and let me know :)

Best,

Antonello

Hi Antonello, does this formula work for any number of years and growth percentage ? Thanks a lot. — Amandine on Nov 12, 2019

Hi Amandine, yes it is the best quick approximation for any number. The more little are the numbers the more accurate is this formula. — Antonello on Nov 12, 2019

Hi Antonello, can you please clarify again how you got the three terms that you use to approximate (1 + 20%)^5? Just tell me how you calculate the first one for example — David on Nov 29, 2019 (edited)

Hi David, it's a classical Math formula. You can find here the theorem: https://en.wikipedia.org/wiki/Binomial_theorem — Antonello on Dec 09, 2019