3.1 Future Value and Compounding Interest
The time value of money (TVM) refers to a dollar in hand today being worth more than a dollar received in the future because you can invest today’s dollar in an interest-bearing account that grows in value over time. We call this the future value (FV), the cash value of an asset (money, in this example) in the future that is equivalent in value to a specific amount today. In this chapter, we’ll examine how interest accumulates (compounding) and how we discount future values to find present values. We’ll look at the flexibility of the time value of money equation, how we can apply it, and one rule of thumb for estimating growth.
The Single-Period Scenario
We’ll kick off with a simple one-period model. ...
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