Question: What is the relationship between Present Value and Future Value?
A future value equals a present value plus the interest that can be earned by having ownership of the money; it is the amount that the present value will grow to over some stated period of time. Conversely, a present value equals the future value minus the interest that comes from ownership of the money; it is today's value of a future amount to be received at some specified time in the future. The future value (FV) measures the nominal future sum of money that a given sum of money is "worth" at a specified time in the future assuming a certain interest rate, or more generally, rate of return. The FV is calculated by multiplying the present value by the accumulation function. PV and FV vary jointly: when one increases, the other increases, assuming that the interest rate and number of periods remain constant. As the interest rate (discount rate) and number of periods increase, FV increases or PV decreases.
What are the calculations involved with PV and FV?
A certain amount of cash in hand today is always better than the same amount to be received in future. This is because amount to be received always has some risk associated with it. So considering those risks a higher amount is desirable over and above the present value.
FV = PV * (1+ interest Rate) compounding period
So the FV is the compounded value of PV
And, PV = FV / (1+ interest Rate) compounding period
So the PV is the discounted value at interest rate of FV.
Compounding period can be different than one year, for example if the interest is compounded semiannually then Compounding period =2 * number of years of maturity.
Interest rate is the rate of one period , for example if the annual rate is 6 % and the interest is paid semiannually then interest rate = 3% for one period.
How can you apply these concepts to a personal or business situation you are familiar with - please explain and support with terms and concepts from this class material?