The Time Value of Money - Part II
Future Value of a Single Sum
amount = lump sum amount invested today
i = expected interest rate or growth rate
n = number of periods (years) that the money will grow
Here's an example:
Say you have $1,000 and you want to invest it. You expect to get a 10% rate of return on this money and expect to invest it for 10 years. How much can you expect it be worth in 10 years?
amount = $10,000
i = .10 (10% expressed as a decimal)
n = 10 years
This example shows us that if you invest $1,000 for 10 years at a 10% rate of return, it will grow to $2,593.
Now, there is a flaw with this formula. Can you figure out what it is? The problem is that it assumes a straight line growth rate of 10%. That is not reality. So, it is important to keep in mind when using this calculation is that it is only an estimate.
That's it for now. Next time we will take this formula a bit further when we talk about future value of multiple cash flows. Ooooh, how exciting!
Tag: Time Value of Money