Finance

Table 2-2 illustrates the four approaches for solving time value of money using an algebraic manipulation solving for present value (PV). Those approaches are: step-by-step, formula approach, financial calculators, and spreadsheets) (Brigham & Houston, 2007). The step-by-step approach shows the time value of money. It helps you to visualize what is happening with your money if you deposit $100 and it accrues 5%interest over a 3-year period.

The formula approach gives a detailed formula, (1 + I)^n. We could apply Equation 2-1 to find the FV, future value in our example. FV = $100(1.05)^3 = $115.76 (Brigham & Houston, 2007).

Using financial calculators is probably the most convenient approach. The buttons that you would use on the calculator are N for the period of time, I for the interest rate, PV for present value, PMT for payment, and FV for future value.

The spreadsheet approach is very similar to the financial calculator. The spreadsheet uses the information that comes from the financial calculator. To calculate the FV in a spreadsheet, you would enter FV (0.05, 3, 0, -100). The numbers entered in the sequence represent interest, periods, 0 to indicate no immediate cash flows, and the present value, PV (Brigham & Houston, 2007).

Using different amounts in the formula, we could calculate the FV on $500 invested for 4 years at a 10% rate. The amount for each year is given below:

0------$500

1------$550

2------$605

3------$665.50

4------$732.05

So, after 4 years, the future value of $500 would be $732.05. This amount was verified using all 4 approaches.

References

Brigham, E.F., & Houston, J.F. (2007). Fundamentals of financial management (11th ed.). Mason, OH: Cengage Learning.