Question

2. Future value Aa Aa E The principal of the time value of money is probably the single most important concept in financial management. One of the most frequently encountered applications involves the calculation of a future value. The process for converting present values into future values is called . This process requires knowledge of the values of three of four time-value-of-money variables. Which of the following is not one of these variables? T O The interest rate (1) that could be earned by deposited funds The trend between the present and future values of an investment The present value (PV) of the amount deposited The duration of the deposit (N) O

Answer 1

• The process of converting present value into future value is called compounding. The variable which is not required is the trend between the present value and future value of an investment. Other variables are required. Future value = Present value*(1+rate of interest)^number of periods. 5. The three lines shows the increase in value with the increase of time period. With higher interest rates the value would be higher in future. At zero interest rate there is no difference between present value and future value. Line A = 21% Line B = 11% Line C = 0% Investments and loans base their interest calculations on one of the two possible methods The Simple Interest methods and the compounding Interest rate method. The correct answer for compounding interest is FV = PV*(1+1)^N The correct answer for simple interest method is FV = PV + (PV*I*N) True: An account that earns compound interest will grow more quickly than simple interest account, other things being same. False: All else equal both the simple interest and compound interest will generate the same amount of interest at the end of first year. True: After the end of second year, the future value based on compounding factor will exceed the present value.

40000 Amount = Time period 6 years Interest rate (%) 8% compounding interest 10% compounding interest 10% Simple Interest Calculation 40000*(1+0.08)^6 40000*(1+0.1)^6 40000+40000*0.1*6 Expected future value Make this investment 63474.97 No 70862.44 Yes 64000.00 No Z