Future Value
Future Value refers to the value of an investment or Cash Flow at a specific point in the future, calculated based on an assumed rate of return or Interest Rate. It takes into account the effects of compounding, which is the process of earning interest on previously earned interest.
Formula: The future value (FV) can be calculated using the formula:
FV = PV × (1 + r)^n
Where:
- PV: Present Value (initial investment or Cash Flow)
- r: Annual Interest Rate (decimal)
- n: Number of years the Money is invested or borrowed
Example 1: If you invest $1,000 at an annual Interest Rate of 5% for 10 years, the future value would be:
FV = 1000 × (1 + 0.05)^10 = 1000 × 1.62889 ≈ $1,628.89
Example 2: A person plans to save $500 annually for 20 years in an account that earns 4% interest. The future value of this annuity can be calculated using a future value of an annuity formula:
FV = PMT × (((1 + r)^n – 1) / r)
Where PMT is the annual payment. Thus:
FV = 500 × (((1 + 0.04)^20 – 1) / 0.04) ≈ $15,000.74
Case: Consider a retiree who wishes to ensure a comfortable retirement. By Investing a portion of their savings into a retirement account with a projected annual return, they can estimate how much their investment will grow over time, allowing for better financial planning and security.