The time value of money may be computed in the following circumstances:
1. Future value of a single cash flow
2. Future value of an annuity
3. Present value of a single cash flow
4. Present value of an annuity
(1) Future Value of a Single Cash Flow
For a given present value (PV) of money, future value of money (FV) after a period ‘t’ for which compounding is done at an interest rate of ‘r’, is given
by the equation
FV = PV (1+r)t
This assumes that compounding is done at discrete intervals. However, in case of continuous compounding, the future value is determined using the formula
FV = PV * ert
Where ‘e’ is a mathematical function called ‘exponential’ the value of exponential (e) = 2.7183. The compounding factor is calculated by taking natural logarithm (log to the base of 2.7183).
Example 1: Calculate the value of a deposit of Rs.2,000 made today, 3 years hence if the interest rate is 10%.
By discrete compounding:
FV = 2,000 * (1+0.10)3 = 2,000 * (1.1)3 = 2,000 * 1.331 = Rs. 2,662
By continuous compounding:
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