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Understanding Future Value Calculations

The document introduces two approaches to calculating the future value of an investment over time: the step-by-step approach and the formula approach. While the step-by-step approach shows the calculation at each period, it is time-consuming. The formula approach uses the compound interest formula to calculate the future value directly, regardless of the number of periods. This allows for quicker calculations, especially for investments over many years. The document then demonstrates using a financial calculator to solve a future value problem by inputting the present value, interest rate, number of periods, and payment.

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158 views1 page

Understanding Future Value Calculations

The document introduces two approaches to calculating the future value of an investment over time: the step-by-step approach and the formula approach. While the step-by-step approach shows the calculation at each period, it is time-consuming. The formula approach uses the compound interest formula to calculate the future value directly, regardless of the number of periods. This allows for quicker calculations, especially for investments over many years. The document then demonstrates using a financial calculator to solve a future value problem by inputting the present value, interest rate, number of periods, and payment.

Uploaded by

adrien_ducaillou
Copyright
© Attribution Non-Commercial (BY-NC)
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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The step-by-step approach is useful because it shows exactly what is happening.

However, this approach is time-consuming, especially if a number of years are involved, so streamlined procedures have been developed.

Formula Approach
In the step-by-step approach above, we multiply the amount at the beginning of each period by (1 _ I) _ (1.05). Notice that the value at the end of Year 2 is If N _ 3, then we multiply PV by (1 _ I) three different times, which is the same as multiplying the beginning amount by (1 _ I)3. This concept can be extended, and the result is this key equation:
(2-1)

We can apply Equation 2-1 via the formula approach to find the FV in our example: Equation 2-1 can be used with any calculator that has an exponential function, making it easy to find FVs, no matter how many years are involved.

Financial Calculators
Financial calculators are extremely helpful when working time value problems. First, note that financial calculators have five keys that correspond to the five variables in the basic time value equations. We show the inputs for our example above the keys and the output, the FV, below its key. Since there are no periodic payments, we enter 0 for PMT. We describe the keys in more detail below the diagram. FV3 _ $10011.052 3 _ $115.76. FVN _ PV11_ I2N. _ 10011.052 2 _ $110.25. _ PV11 _ I2 2 _ PV11 _ I2 11 _ I2 FV2 _ FV111 _ I2
Future Values 41

N _ Number of periods. Some calculators use n rather than N. I/YR _ Interest rate per period. Some calculators use i or I rather than I/YR. PV _ Present value. In our example we begin by making a deposit, which is an outflow, so the PV should be entered with a negative sign. On most calculators you must enter the 100, then press the _/_ key to switch from _100 to _100. If you enter _100 directly, this will subtract 100 from the last number in the calculator and give you an incorrect answer. PMT _ Payment. This key is used if we have a series of equal, or constant, payments. Since there are no such payments in our illustrative problem, we enter PMT _ 0. We will use the PMT key when we discuss annuities later in this chapter.

FV
115.76

PMT
0

PV
100

I/YR
5

N
3 Output: Inputs:

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