FPO 101

Building on the first two lessons, this lesson adds the calculations for finding the present value, future value, or any other unknown for a stream of cast flows.

“I invest $1000 for a period of 7 years in a long-term CD at an annual interest rate of 3.5%. What will my future value be?”

The first step is to establish our variables:

i=3.5%, t=7, P=1000, F=unsolved

F=1000*(1.035)^7=$1272.28

A gain of $272.28 over the 7 years.

This was solved in lesson #1. Let’s change this to where I don’t invest that $1000 until 1 year has passed. I want to know what I would have had to invest today for that to be equivalent. The period of investment is still seven years, but adding the one year that has passed, now my total period is 8 years.

I don’t have to recalculate everything, since the terms remain the same. If I look at my present situation, i want to know how much money I need now at 3.5% annual (If it isn’t stated otherwise, APR will equal APY in these problems).

With a time of 1 year, I divide my Future Value by 1.035^t; where t=1. The result is a present value at year 0 of $966.18

If I delayed starting until year 2, with the same seven-year investment period, it would be the equivalent of starting today with $1000/(1.035^2) = $933.51

With all of this I will still have the same ending value of $1272.28 at either year 7, 8, or 9 depending on when I was at the $1000 value point.

 

Past FPO 101 Lessons:
Lesson #1: The Time Value of Money
Lesson #2: APR vs. APY

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