- Budgeting
- Cash Management
- Consumer and Mortgage Loans
- Debt and Debt Reduction
- Time Value of Money 1: Present and Future Value
- Time Value of Money 2: Inflation, Real Returns, Annuities, and Amortized Loans
- Insurance 1: Basics
- Insurance 2: Life Insurance
- Insurance 3: Health, Long-term Care, and Disability Insurance
- Insurance 4: Auto, Homeowners, and Liability Insurance
- The Home Decision
- The Auto Decision
- Family 1: Money and Marriage
- Family 2: Teaching Children Financial Responsibility
- Family 3: Financing Children’s Education and Missions
- Investments A: Key Lessons of Investing
- Investments B: Key Lessons of Investing
Problem 2: Determining Present Value
Let’s suppose your rich uncle promises to give you $500,000 in forty years. Assuming a 6 percent interest rate, what is the present value of the amount your uncle is promising to give you in forty years?
To solve this problem, use the equation given above, which would appear as follows: PV = 500,000/ (1 +.06)40, or $48,611. You can also use a financial calculator. Set your calculator to end mode, meaning payments are at the end of each period, and clear the memory registers to make sure you have no old data in the calculator memories. Set $500,000 as your future value (FV), 40 as your number of years (N), and 6 as your interest rate (I); then solve for the present value (PV). You should get the same result as you did when you used the PV equation.
Future Value (FV)
Let’s suppose you want to determine what an investment will be worth at some point in the future. (What will the value of my investment be in n years if my interest rate is i percent?)
You will need to know how many years it will be until you have the investment, the interest rate, and the amount of the investment (the present value of the investment).
The result of the equation will be a dollar amount that is larger than the original investment, since your money will earn interest and will then earn interest on that interest. For an approximation, remember the rule of seventy-two. The rule of seventy-two states that an investment will double approximately each time you multiply the number of years of investment by the interest rate (in percentage terms) and get a number that is greater than seventy-two. For example, if your investment is earning 8 percent interest, it will take nine years for it to double (72 divided by 8 = 9).
The future value (FV) equation is as follows:
FV = PV * (1 + interest rate)n
In this equation, n equals the number of periods (years in this case).
The key inputs in the FV equation are as follows:
FV = the future value of the investment at the end of n periods (years)
N = the number of years in the future
I = the interest rate, or the annual interest (or discount) rate
PV = the present value, in today’s dollars, of a sum of money that you have already invested or plan to invest
