Compounding interest
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Compounding Interest. How it works…. Concepts. Future Value : determine what your money will be worth in a given number of years. Present Value : present day value of an amount that is received at a future. Payments : The amount of money you must pay each period on a loan

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Concepts
Concepts

  • Future Value: determine what your money will be worth in a given number of years.

  • Present Value: present day value of an amount that is received at a future.

  • Payments: The amount of money you must pay each period on a loan

  • Net Present Value: the present value of net cash inflows generated by a project


Future Value on an Investment

BASED ON THE COMPOUND INTEREST FORMULA

annual interest rate(as a decimal)

Principal(amount at start)

time(in years)

amount at the end

number of times per year that interest in compounded


Present value p v
Present ValuePV

  • i:interest rate per compounding period; andn: the number of compounding periods.

Example: An investment consultant tells you that if you invest in a certain contract, you will receive exactly $10,000in one year. How much should you invest in this contract, assuming you demand a 4% return (yield) on your money?



Net present value npv
Net Present ValueNPV

Decision Rule: Accept the project only if its NPV is positive or zero. Reject the project having negative NPV.


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