Final answer:
The statement given is true; compound interest indeed takes the interest accumulated in one period and adds it to the principal for the next period's interest calculation.
Step-by-step explanation:
Compound interest is the process where the interest for one period is added to the principal, and the new total becomes the principal for the calculation of interest in the next period. This means that you not only earn interest on your original investment but also on the interest it has already earned.
Let's consider the formula for compound interest:
Future Value = Principal x (1 + interest rate)time Compound Interest = Future Value - Present Value
To illustrate, for a three-year investment scenario:
Calculate the Future Value using the compound interest formula.
Subtract the original principal from the Future Value to find the compound interest earned over the three years.
In contrast, simple interest is calculated only on the principal amount without compounding. For example, a $100 principal at a 5% annual rate over three years would yield a total future amount of $115 with simple interest.