Future Values 45

The important thing is that you understand the various approaches well enough to make a rational choice, given the nature of the problem and the equipment you have available. In any event, you must understand the concepts behind the calculations and know how to set up time lines in order to work complex problems. This is true for stock and bond valuation, capital budgeting, lease analysis, and many other important financial problems.

Graphic View of the Compounding Process

Figure 2-2 shows how a $1 investment grows over time at different interest rates. We made the curves by solving Equation 2-1 with different values for N and I. The interest rate is a growth rate: If a sum is deposited and earns 5% interest per year, then the funds on deposit will grow by 5% per year. Note also that time value concepts can be applied to anything that growssales, population, earnings per share, or your future salary.
Future Value of $1 0 1 2 3 4 5 6 7 8 9 10 1.00 2.00 3.00 4.00 5.00 6.00 I = 0% I = 5% I = 10% I = 20% Periods

Growth of $1 at Various Interest Rates and Time Periods

Figure 2-2 Explain why this statement is true: A dollar in hand today is worth more than a dollar to be received next year. What is compounding? What would the future value of $100 be after 5 years at 10% compound interest? ($161.05) Suppose you currently have $2,000 and plan to purchase a 3-year certificate of deposit (CD) that pays 4% interest compounded annually. How much will you have when the CD matures? How would your answer change if the interest rate were 5%, or 6%, or 20%? ($2,249.73; $2,315.25; $2,382.03; $3,456.00) (Hint: With a calculator, enter N _ 3, I/YR _ 4, PV _ _2000, and PMT _ 0, then press FV to get 2,249.73. Then, enter I/YR _ 5 to override the 4% and press FV again to get the second answer. In general, you can change one input at a time to see how the output changes.) A companys sales in 2005 were $100 million. If sales grow at 8%, what will they be 10 years later, in 2015? ($215.89 million) How much would $1, growing at 5% per year, be worth after 100 years? What would FV be if the growth rate were 10%? ($131.50; $13,780.61)

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