BUS601: Financial Management

There are benefits to investing money now in hopes of a larger return in the future. These future earnings are possible because of interest payments received as an incentive for tying up money long-term. Knowing what these future earnings will be can help a business decide if the current investment is worth the long-term potential. Recall the future value (FV) as the value of an investment after a certain period of time. Future value considers the initial amount invested, the time period of earnings, and the earnings interest rate in the calculation. For example, a bank would consider the future value of a loan based on whether a long-time client meets a certain interest rate return when determining whether to approve the loan.

To determine future value, the bank would need some means to determine the future value of the loan. The bank could use formulas, future value tables, a financial calculator, or a spreadsheet application. The same is true for present value calculations. Due to the variety of calculators and spreadsheet applications, we will present the determination of both present and future values using tables. In many college courses today, these tables are used primarily because they are relatively simple to understand while demonstrating the material. For those who prefer formulas, the different formulas used to create each table are printed at the top of the corresponding table. In many finance classes, you will learn how to utilize the formulas. Regarding the use of a financial calculator, while all are similar, the user manual or a quick internet search will provide specific directions for each financial calculator. As for a spreadsheet application such as Microsoft Excel, there are some common formulas, shown in Table 11.2. In addition, Appendix C provides links to videos and tutorials on using specific aspects of Excel, such as future and present value techniques.

Time Value of Money Tables

Future Value of $1

A lump sum payment is the present value of an investment when the return will occur at the end of the period in one installment. To determine this return, the Future Value of $1 table is used.

For example, you are saving for a vacation you plan to take in 6 years and want to know how much your initial savings will yield in the future. You decide to place $4,500 in an investment account now that yields an anticipated annual return of 8%. Looking at the FV table, n = 6 years, and i = 8%, which return a future value factor of 1.587. Multiplying this factor by the initial investment amount of $4,500 produces $7,141.50. This means your initial savings of $4,500 will be worth approximately $7,141.50 in 6 years.

Future Value of an Ordinary Annuity

An ordinary annuity is one in which the payments are made at the end of each period in equal installments. A future value ordinary annuity looks at the value of the current investment in the future, if periodic payments were made throughout the life of the series.

For example, you are saving for retirement and expect to contribute $10,000 per year for the next 15 years to a 401(k) retirement plan. The plan anticipates a periodic interest yield of 12%. How much would your investment be worth in the future meeting these criteria? In this case, you would use the Future Value of an Ordinary Annuity table. The relevant factor where n = 15 and i = 12% is 37.280. Multiplying the factor by the amount of the cash flow yields a future value of these installment savings of (37.280 × $10,000) $372,800. Therefore, you could expect your investment to be worth $372,800 at the end of 15 years, given the parameters.