Future value

Future value is the value of an asset at a certain point in the future based on an assumed rate of return. It is calculated by multiplying the present value (the current value of the asset) by a rate of return, which is usually compounded annually. The formula for calculating future value is:

Example of Future value

As an example of future value, let's say you have $10,000 that you invest for 10 years at a 5% annual rate of return. The future value of this investment would be:

Future Value = $10,000 x (1 + 0.05)¹⁰ Future Value = $16,288.90

In this example, the future value of the investment is $16,288.90, which is $6,288.90 more than the original investment of $10,000. This is the power of compounding returns, which allows an investment to grow over time.

Formula of Future value

The formula of future value is used to calculate the value of an asset at a certain point in the future. It is calculated by multiplying the present value of the asset by a rate of return, usually compounded annually. The formula for calculating future value is:

Future Value = Present Value x (1 + Rate of Return)^{Number of Periods}

When to use Future value

Future value is used in finance to determine how much an investment will be worth in the future. It can also be used to compare investments to decide which will be more profitable over time. For example, if you have two investment options with different rates of return and you want to decide which one to choose, you can use the future value calculation to determine which will be more valuable in the future. Additionally, it can be used to determine how much money you need to save to reach a certain goal by a certain date.

Types of Future value

• Nominal Future Value: This is the future value of an asset, without taking into account inflation. It is calculated using the formula above, with the rate of return being the nominal rate (the rate of return before accounting for inflation).
• Real Future Value: This is the future value of an asset, taking into account inflation. It is calculated using the formula above, with the rate of return being the real rate (the rate of return after accounting for inflation).

Steps of Future value

1. Determine the present value: This is the value of the asset today.
2. Determine the rate of return: This is the rate of return you can expect to earn on the asset.
3. Calculate the number of periods: This is the number of years the asset will be held.
4. Calculate the future value: The future value is calculated by multiplying the present value by the rate of return and then raising it to the number of periods.

Advantages of Future value

• Future value allows investors to plan ahead and decide how much money they need to invest in order to achieve a certain goal. By taking into account the rate of return and the length of time, investors can calculate how much money they need to invest in order to reach a certain goal.
• Future value also allows investors to make educated decisions when it comes to investing. By making an estimate of how much money an asset will be worth in the future, investors can make more informed decisions when it comes to where and how to invest their money.
• Finally, future value can help investors to make more efficient use of their funds. By calculating the future value of their investments, investors can decide the best way to allocate their funds and make sure that their money is working for them in the most effective way possible.

Limitations of Future value

Future value calculations are limited by the accuracy of the inputs provided. Factors such as inflation, investment gains or losses and other market influences are difficult to predict, making the calculation of future value an estimate at best. Furthermore, the calculation assumes that the rate of return remains constant over the entire period, which is rarely the case.

Additionally, the calculation is limited by the number of compounding periods in the future. For example, if you are calculating the future value of an asset in 10 years, the calculation will only be accurate if the rate of return remains constant over that 10-year period. If the rate of return is expected to change, the calculation will be inaccurate.

Other approaches related to Future value

Besides the formula mentioned above, there are other approaches related to future value. These include:

• Annuity: An annuity is an arrangement in which a fixed sum of money is paid or received at regular intervals for a fixed period of time. This approach can be used to calculate future value if the cash flow is fixed and the rate of return is known.
• Amortization: Amortization is a way of spreading the cost of an asset over its useful life. This method is useful for calculating future value when the cash flows are known and the rate of return is not.
• Compounding: Compounding is the process of reinvesting the interest earned in an asset to increase its value. This approach can be used to calculate future value if the cash flows are not known and the rate of return is known.

In summary, Future value is the value of an asset at a certain point in the future based on an assumed rate of return. There are several approaches related to future value, including Annuity, Amortization, and Compounding.

Future value — recommended articles

Effective annual interest rate — Net present value (NPV) — Real rate of return — Effective interest method — Treasury Stock Method — Profitability index — Risk-return tradeoff — Payback period — Annualized rate

References

• Marr, B. (2008). Impacting future value: how to manage your intellectual capital.
• Kubiszewski, I., Costanza, R., Anderson, S., & Sutton, P. (2020). The future value of ecosystem services: Global scenarios and national implications. In Environmental Assessments (pp. 81-108). Edward Elgar Publishing.