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Future Value

1. The document discusses the concepts of future value and present value. Future value calculates the value of a cash flow in the future, while present value calculates the current value of future cash flows. 2. Formulas are provided to calculate the future value of a single cash flow and an annuity. An example shows calculating the future value of investing $125,000 annually for 5 years at 8% interest. 3. Present value formulas are also provided to calculate the current worth of a single future amount and an annuity. An example calculates the present value of receiving $8,000 in 5 years at 12% interest. Another example calculates the present value of an annuity of $50,000 annually

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97 views4 pages

Future Value

1. The document discusses the concepts of future value and present value. Future value calculates the value of a cash flow in the future, while present value calculates the current value of future cash flows. 2. Formulas are provided to calculate the future value of a single cash flow and an annuity. An example shows calculating the future value of investing $125,000 annually for 5 years at 8% interest. 3. Present value formulas are also provided to calculate the current worth of a single future amount and an annuity. An example calculates the present value of receiving $8,000 in 5 years at 12% interest. Another example calculates the present value of an annuity of $50,000 annually

Uploaded by

teja
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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FUTURE VALUE

1. Future Value of a Single Cash Flow

The term (1+ i)n is the compound value factor (CVF) of a lump sum of `1, and it always has a value greater than 1
for positive i, indicating that CVF increases as I and n increase. The compound value can be computed for any lump
sum amount at i rate of interest for n number of years, using the given equation.

2. Future Value of an Annuity Example

Assume someone decides to invest $125,000 per year for the next five years in an
annuity they expect to compound at 8% per year. In this example, the series of
payments is a regular annuity in which the payments are made at the end of each
period. The expected future value of this payment stream using the above formula is
as follows:
Future value=$125,000×((1+0.08)5−1)0.08=$733,325
CVFA:

PRESENT VALUE
With the compounding technique, the amount of present cash can be converted into an amount of cash of
equivalent value in future. However, it is a common practice to translate future cash flows into their present
values. Present value of a future cash flow (inflow or outflow) is the amount of current cash that is of
equivalent value to the decision maker

1. Formula For Present Value of a Single Amount


The formula used to calculate the present value of a single amount is:
In this formula, the following variables are defined as:

 PV = Present value of the amount

 FV = Future value of the amount (amount to be received in


future)

 i = Interest rate (in percentage terms)

 n = Number of periods after which the amount will be received


in future
Example
Suppose a company expects to receive $8,000 after 5 years. Calculate
the present value of this sum if the current market interest rate is 12% and
the interest is compounded annually.

Solution
The way to solve this is to apply the above present value formula. In this
example, the number of periods (n) is 5 and the interest rate (i) is 12%.
Therefore, the present value (PV) is calculated as follows:

PV = FV x 1 / (1+i) n

= 8,000 x 1 / (1+12%) 5

= 8,000 x 1 / (1+0.12) 5

= 8,000 x 1 / (1.12) 5

= 8,000 x 1 / 1.7623

= 8,000 x 0.5674

= $4,540

Present value factor

2. Present Value of an Annuity

Example of the Present Value of an Annuity


Assume a person has the opportunity to receive an ordinary annuity that pays $50,000 per
year for the next 25 years, with a 6% discount rate, or take a $650,000 lump-sum payment.
Which is the better option? Using the above formula, the present value of the annuity is:

Present value=$50,000×1−(1(1+0.06)25)0.06=$639,168Present value


=$50,000×0.061−((1+0.06)251)=$639,168

Present value factor of annuity

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