Time value of an investment can simply be said to be the future value of an investment or what it will be worth after compound interest over a period of time.
Investments may be arranged or positioned with time like the monthly addition to your hundred thousand Dollars in the bank or it may be a lump sum as in the case of the purchase of an annuity. In the case of purchasing annuity, one can calculate the time value of his investment using a financial formula known as the future value of a lump sum investment.
There are three separate ways of calculating this, each method makes use of different means of calculation but they are all pointing at the same one direction. They are:
THE PROBLEM VS FUTURE VALUE FORMULA
Take for instance, an investor has 100 000 Dollar and the interest rate is 5%. To determine the value of the investment at the end of the year, this formula should be used:
PV (1+1) n
Where PV = present value
1 = interest rate
n = number of compounding periods.
Using the example from above; in a year, the 100 000 Dollar lump sum investment earning at a 5% interest per annum added will be =
FV = 100 000 (1+0.05) = 105 000
In this instance, there is no superscript (n) for compounding periods because the solution is just for a year alone. But to determine the value in two years the superscript will have to be two meaning that it will now be:
FV = 100 000 (1+0.05)² = 110 250
Going by this formula, for an investor to calculate an extended period of time, it will be difficult. For example if he wishes to solve for 30 years, it means he will have to go through this formula 30 times. There are other easier and faster ways by using the financial calculator.
USING FINANCIAL CALCULATOR
Using the financial calculator, the formula for finding time value of an investment is
Fan = PV (1+1) n
This formula can be used with any calculator that has an exponential function key. Using a financial calculator is better than the first formula because it has specific keys rhyming with each of the four variables used which helps to speed up the process and reduce the error margin. For the variables use these keys:
Press N and 2 for 2 years
Press I/YR and 5 for interest rate of 5%
Press PV and -105000 for the amount we want to get the interest on in 2 years
Press PMT meaning no payment after the first one
Then press FV, which gives the answer.
USING A SPREADSHEET
Using a spreadsheet is also easy, the function used for future value calculation on an Excel spreadsheet is:
FV (0.05, 1, 0,-100000, 0)
Check on formula in the title bar and then on financial, click on FV and the formula builder box will come out where you will see boxes labeled rate, PV, nper, PMT, and type. To determine the future value for two years, complete the boxes as follows:
Rate = 0.05
nper = number of payment period which is 2
PMT = repeated payments which is 0
PV = present value, written as a negative -100 000
Type = which is timing of subsequent payment 0
Then for earlier versions of Excel click calculate and the result will come out. Later versions calculate automatically.
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.