Handout #1 - Future Value measures the nominal “worth”...

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Unformatted text preview: Future Value measures the nominal “worth” of money at a predetermined point in the future (nominal: measuring in amount and not in “real value’ —real value being the amount’s worth in present time). Initial Income: 42,000 (per year) Time: 42 (years) Rate (of growth): 2.5 (percent per year, .025) The rate at which income may grow can depend on many factors and namely those which the employer takes into account. For this example we will choose a static growth rate of 2.5 percent which is close to the average inflation rate over the last several years. However, it’s important to remember that inflation varies depending on market cycles and other factors. Thus, an accurate representation of money growth depending on a single factor such as inflation can be much more complicated. FV = Initial Value + Initial Value * (1 + r) + Initial Value * (1+r)"2 + ...... .....+ Initial Value * (I+r)"t Note: This equation is for a compounding interest rate. For a simple interest rate it would simply be Initial Value * (1+rt). FV = 42,000 + 42,000 * (1+.025) + 42,000(1.025)02+. . ...+42,000(1.025)"t = z 42,000*(1+.025)"l< (fiom kzo to k=42) Which is approximately equal to 3,177,754 (plugged into calculator). Present Value is the measure of the worth of future payment’s discounted for the time value of money for a given date (usually now, however this formula is sometimes used to calculate other given points in time). Same parameters as above. Interest rate: Case 1: .05 (5 percent) Case 2: .12 (12 percent) The interest rate used is the discounted value of the money. Like the rate of growth, the discounted value tends to change over time and can include many factors such as inflation, risk, etc. Thus, it is often much more complicated than this watered down version. PV =—* Initial Value + Initial Value * (1 + r)l(1+i) + Initial Value * (1+r)"2/(1+i)"2 + ........... + Initial Value * (1+r)"tl(l+i)"t. PV(1) = 42,000 + 42,000 * (1+.025)/(1+.05) + 42,0000.025)A2/(1+.05)02+.. ...+ 42,000(1.025)At/(1+.05)At = z 42,000*(1+.025)"k/(1+.05)"k (from k=0 to k=42) Which is approximately equal to 1,13 8,128. ...
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