In the previous article we discussed how it is that we can use the present value function to understand what a set payment schedule is worth to us in terms of dollars today. While present value is very useful for us to compare different investment opportunities in terms of their worth to us today, the future value equation helps us to evaluate the true costs of our debts and obligations, by showing us exactly how much will be paid out in total over the course of the same payment schedule.
The future value equation is similar to the present value function, in that it requires the same information to calculate (payment amount, number of payment periods, and interest rate). That being said, the future value equation differs slightly in the way that it is calculated.
Future Value=Payments (1+Interest Rate) #PeriodsInterest Rate-1Interest Rate
Looking again at our bond that pays out $200 semi-annually for 5 years in an environment where a savings account pays out 3%/year, which we will remember had a present value of $1844.44, we can see that the equation is calculated as follows: Continue reading