Definition of Future Value
Future value is used to value an asset at a specific date that possesses similar value to a specific sum today. It helps to measure the conversion of given sum of money within a specific in future, assuming a certain interest rate, or more generally, rate of return. Future value is basically the present value multiplied by the accumulation function. Any other factors like fluctuating interest rates or fluctuating currency values that have an effect on future of money in future or corrections for inflations are not involves in future value method.
The usage of future is mainly on the time value of money calculations. There are two paths with which future value can be calculated, and those are,
- For an asset with simple annual interest: = Original Investment x (1+(interest rate*number of years))
- For an asset with interest compounded annually: = Original Investment x ((1+interest rate)^number of years).
Books on Future Value
Book 1:
Introduction to Corporate Finance: What Companies Do By John Graham, Scott Smart (published by Cengage Learning, 2011)
Book 2:
Managerial Accounting: Tools for Business Decision Making By Jerry J. Weygandt, Paul D. Kimmel, Donald E. Kieso (published by John Wiley & Sons, 2009)
How Future Value works?
With a few practical examples the perception of future value can be accomplished, here two of examples are discussed in order to clear the idea.
Suppose, let’s say a person has made a investment worth of $1,000 with the interest rate of 10% for five years, so future value would be,
Future Value = $1,000 x [1 + (0.1 x 5)]
Future Value = $1,000 x 1.5
Future Value = $1,500
Future value undergone the compounding method, can be calculated in this manner,
Future Value = Present Value x [(1 + Interest Rate) Number of Years]
Let’s say a person has invested $1,000 for five years with the interest rate of 10%, compounded annually, so the future value would be,
Future Value = $1,000 x [(1 + 0.1)5]
Future Value = $1,000 x 1.61051
Future Value = $1,610.51
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