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The Time Value of Money
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| Present Value | How much you got now. |
| Future Value | How much what you got now grows to when compounded at a given rate |
I give you 100 dollars. You take it to the bank. They will give you 10% interest per year for 2 year.
- The Present Value = $ 100
- Future Value = $121.
| FV= PV (1 + i )N |
- FV = Future Value
- PV = Present Value
- i = the interest rate per period
- n= the number of compounding periods
What is the future value of $34 in 5 years if the interest rate is 5%?
- FV= PV ( 1 + i ) N
- FV= $ 34 ( 1+ .05 ) 5
- FV= $ 34 (1.2762815)
- FV= $43.39.
You can go backwards too. I will give you $1000 in 5 years. How much money should you give me now to make it fair to me. You think a good interest rate would be 6% ( You just made that number up).
- FV= PV ( 1 + i ) N
- $1000 = PV ( 1 + .06) 5
- $1000 = PV (1.338)
- $1000 / 1.338 = PV
- $ 747.38 = PV
O.K. so you give me $ 747.38 today and in 5 years I'll give you $1000. Sound fair?? You will get 6% interest on your money.