In the modern competitive business environment, the ultimate objective of the most of the companies is to increase their ROI (Return On Investment) while minimizing the risk. Therefore, these companies are always concerned about the returns they get for their investments. Therefore, future value calculations have been so important for the analysts in order to make more accurate and effective strategic decisions on behalf of the organization. This article explains how to calculate future value in detail.
Future Value Formula
The calculation of the Future Value (FV) of cash flows is useful to identify the amount that would be received in the future with regard to the current investment. There is a specific formula that can be used to calculate Future Value as illustrated below:
FV = PV*(1 + r)n
Where, FV = Future Value, PV = Present Value, r = discount rate, and n= time period
To calculate future value of cash flows two methods can be followed:
Calculate future value using simple annual interest rates
FV Calculation Example:
Mr. X invests an amount of $1,000 today at an interest rate of 5%. After ten years time, his income can be calculated using Future Value Formula as below:
FV = $1,000 * (1+5%)10 =$1,628.89
The future value factor is based on the concept of the time value of money. The value of $1,000 is lesser in ten years time. Because the value of the money depreciated over time. Therefore, it is better to invest the additional cash rather than keeping them safely with you.
The future value formula is used in many areas of businesses. This formula has been incorporated into other formulas as well. For example, an annuity in the form of regular deposits in an interest account would be calculated as the addition of the future value of each deposit. Most of the financial institutions use the future value formula and concept for banking investments, corporate finance, etc.
Calculate future value using compounded interest rates
This future value formula is having the impact of compounding interest. If a person is reinvesting his/her monthly earnings he/she gets an additional cash for their investments. This is known as the compounding interest.
FV Calculation Example:
If A makes a deposit of $100 today. He is expected to invest it for four years at 8% per year compounded monthly. The future value of the deposit at the end of four years can be calculated as follows:
FV = $100 * (1+0.67%)4= $102.69
Why is it important to calculate future value
The level of risk
In the organizational perspective, before investing on larger projects, they can measure whether the projects are financially feasible or not. They can make the estimations based on the data available and make their final conclusions.
In most cases, the future value investments take time. They completely differ from investments in stocksthat can generate large returns or losses. Over time, the value of money goes down. Therefore, it is required to be concerned about the time value of money when the projects are taking longer time to finish.