Future Value

What is 'Future Value - FV'

The future value (FV) is the value of a current asset at a specified date in the future based on
an assumed rate of growth over time.

If, based on a guaranteed growth rate, a $10,000 investment made today will be worth $100,000 in
20 years, then the FV of the $10,000 investment is $100,000. The FV equation assumes a
constant rate of growth and a single upfront payment left untouched for the duration of the
investment

BREAKING DOWN 'Future Value - FV

The FV calculation allows investors to predict, with varying degrees of accuracy, the amount of
profit that can be generated by different investments. The amount of growth generated by holding a
given amount in cash will likely be different than if that same amount were invested in stocks, so
the FV equation is used to compare multiple options.

Determining the FV of an asset can become complicated, depending on the type of asset. In
addition, the FV calculation is based on the assumption of a stable growth rate. If money is placed
in a savings account with a guaranteed interest rate, then the FV is easy to determine accurately.
However, investments in the stock market or other securities with a more volatile rate of return can
present greater difficulty. For the purposes of understanding the core concept, however, simple
and compound interest rates are the simplest examples of the FV calculation.

Simple Annual Interest

The FV calculation can be done one of two ways depending on the type of interest being earned. If
an investment earns simple interest, then the formula is as follows:
FV = I * (1 + (R * T))

where I is the initial investment amount, R is the interest rate and T is the number of years the
investment will be held.

For example, assume a $1,000 investment is held for five years in a savings account with 10%
simple interest paid annually. In this case, the FV of the $1,000 initial investment is $1,000 * (1 +
(0.10 * 5)), or $1,500.

Compounded Annual Interest

With simple interest, it is assumed that the interest rate is earned only on the initial investment.
With compounded interest, the rate is applied to each year's cumulative account balance. In the
example above, the first year of investment earns 10% * $1,000, or $100, in interest. The following
year, however, the account total is $1,100 rather than $1,000, so the 10% interest rate is applied to
the full balance for second-year interest earnings of 10% * $1,100, or $110.

The formula for the FV of an investment earning compounding interest is:

FV = I * ((1 + R) ^ T)

Using the above example, the same $1,000 invested for five years in a savings account with a 10%
compounding interest rate would have a FV of $1,000 * ((1 + 0.10) ^ 5), or $1,610.51.

Future Value (With Intraperiod Compounding)

Compounding that occurs more than once a year is called intraperiod compounding. The
calendar period over which compounding occurs is called the compounding period. For example,
compounding may occur annually, semi-annually, quarterly, or monthly. When using intraperiod
compounding, the future value formula must be modified to reflect the number of times per year
compounding occurs, denoted by m.

= {1 + }

Example:
Instead of placing P1,000 in Atlanta Bank that pays 10% interest annually, the financial manager
decides to put the money in National Bank that pays 10% interest compounded semi-annually .
between the two banks, there would be a difference in the future value of your investment after one
year.
Atlanta Bank National Bank
Annual Compounding Semiannual Compounding
0.10
FV1 = (P1,000)(1+0.10)1 FV1 = (P1,000)(1+ 2 )(2)(1)
= (P1,000)(1.10) = (P1,000)(1.1025)
= P1,100.00 = P1,102.50

Now, Subtract P1,100 from P1,102.50 to find the difference in future values of P2.50. thus, more
interest is earned with semiannual compounding than with annual compounding.

Increase the frequency of the compounding period makes the future value grow more rapidly
because more interest is earned on the changing balance.