Suppose now you have $3000 in hand today,it must be worth more than someone promise to give you $3000 in the next 2 year.because with $3000 in hand today, it can be invested in a bank or fixed income securities(Bond) for example 5% interest rate,so in the next 2 year you will have the principle + interest income.
Formula
FV = PV(1 + r)t
- FV = future value
- PV = present value
- r = period interest rate, expressed as a decimal
- T = number of periods
- Future value interest factor(FVIF) = (1 + r)t
Example:
Method 1
Future Value (FV) = $3,000(1 + .05)^2 = $3,306
Method 2
PV = present value =$3000
r= 5%
T=2 year
Future value interest factor (FVIF) = (1 + r)t can be found in the table below is the interest rate 5% for 2 years is (1+r)t = 1.102
Future Value (FV) = PV(FVIFi,n) or $3,000(1.102) = $3,306
Method 3
Using Financial calculator
Present Value: is the The current worth of a future sum of money or stream of cash flows discounted by the Interest rate (Discount rate,Cost of capital, Opportunity cost of capital,Required return)
As we can see in the previous example that $3000 to be received in the next 2 year probably worth less than $3000 in hand today.because $3000 today can be saved with 5% interest rate and in the 2 years time we will receive $3,306. so to find the 3000$ to be received in the next 2 year and how much it's worth today,it have to be discounted with 5% as an opportunity cost.
Formula
PV = FV/(1 + r)t or FV*( 1/(1+r)t)
- FV = future value
- PV = present value
- r = period interest rate, expressed as a decimal
- T = number of periods
- Present value interest factor(PVIF) = 1/(1 + r)t or Discount Factor
Example:
Method 1
Present Value (PV) = $3,000/(1 + .05)^2 = $2,721
Method 2
FV = Future value =$3000
r= 5%
T=2 year
Present value interest factor(PVIF) or Discount Factor = (1 + r)t can be found in the table below is the interest rate 5% for 2 years is 1/(1+r)t =0.907
Present Value (PV) = FV(PVIFi,n) or $3,000(0.907) = $2,721
Method 4
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