Future Value
by MaestriA dollar in hand today is worth more than a dollar to be received in the future because, if you had it now, you could invest it, earn interest, and end up with more than one dollar in the future. The process of going from today’s values, or present values (PVs), to future values (FVs) is called compounding. To illustrate, suppose you deposit $100 in a bank that pays 5 percent interest each year. How much would you have at the end of one year? To begin, we de?ne the following terms:
PV = present value, or beginning amount, in your account. Here PV = $100.
i = interest rate the bank pays on the account per year. The interest earned is based on the balance at the beginning of each year, and we assume that it is paid at the end of the year. Here i 5%, or, expressed as a decimal, i 0.05. Throughout this chapter, we designate the interest rate as i (or I) because that symbol is used on most ?nancial calculators. Note, though, that in later chapters we use the symbol r to denote interest rates because r is used more often in the ?nancial literature.
INT = dollars of interest you earn during the year = Beginning amount = i. Here
INT = $100(0.05) = $5.
FVn = future value, or ending amount, of your account at the end of n years.
Whereas PV is the value now, or the present value, FVn is the value n years
into the future, after the interest earned has been added to the account.
n = number of periods involved in the analysis. Here n = 1
Thus, the future value (FV) at the end of one year, FV1, equals the present value multiplied by 1 plus the interest rate, so you will have $105 after one year.
Taken From : Five-Minute MBA – Corporate Finance
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