December 2010
Intermediate to advanced
848 pages
31h 28m
English
Content preview from Financial Accounting: In an Economic ContextBecome an O’Reilly member and get unlimited access to this title plus top books and audiobooks from O’Reilly and nearly 200 top publishers, thousands of courses curated by job role, 150+ live events each month,
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TIME VALUE COMPUTATIONS
Computations involving the time value of money can be viewed from either of two perspectives: (1) the future value of a sum of money received today or (2) the present value of a sum of money received in the future. The following sections discuss these two perspectives.
Future Value
In our discussion of the time value of money, we stated that $1 invested at a given interest rate for a period of time will grow to an amount greater than $1. This dollar amount is called the future value.
SIMPLE INTEREST
As in the example above, $1 invested at a 10 percent per year interest rate will grow to $1.10 ($1 X 1.10) at the end of one year. This $1.10 is referred to as the future value in one year of $1, given a 10 percent interest rate. In such a situation, an individual would be indifferent as to receiving $1 now or $1.10 in one year. A simple interest calculation for one year is as follows.
COMPOUND INTEREST
If we wish to compute the future value of $1 at the end of more than one period (say, two years), given a 10 percent interest rate, we use the notion of compound interest. That is, in the second year, the 10 percent interest rate is applied to both the original $1 principal and the $0.10 interest earned in the first year. Here, the future value of $1 at the end of two years, given a 10 percent interest rate compounded annually, is equal to $1.21. An individual ...
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