future value

Fin

the value that a sum of money will have in the future, taking into account the effects of inflation, interest rates, or currency values.

EXAMPLE

Future value calculations require three figures: the sum in question, the percentage by which it will increase or decrease, and the period of time. In this example, these figures are $1,000, 11%, and two years.

     At an interest rate of 11%, the sum of $1,000 will grow to $1,232 in two years:

$1,000 × 1.11 = $1,110 (first year) × 1.11 = $1,232 (second year, rounded to whole dollars)

Note that the interest earned in the first year generates additional interest in the second year, a practice known as compounding. When large sums are in question, the effect of compounding can be significant.

     At an inflation rate of 11%, by comparison, the sum of $1,000 will shrink to $812 in two years:

$1,000 /1.11 = $901 (first year) /1.11 = $812 (second year, rounded to whole dollars)

In order to avoid errors, it is important to express the percentage as 1.11 and multiply and divide by that figure, instead of using 11%; and to calculate each year, quarter, or month separately.

See also present value