Analytical Methodsfor Lawyers (Finance)

Future value

[last updated 6 Apr 09]

“The most powerful force in the universe is compound interest”.

Value of $1000?

I offer you either $500 today or $800 in three years.

Which is better?

Time value of money

Invest $500 10% Balance

Year 1Year 2Year 3

$50.00$55.00$60.50

$550.00$605.00$665.50

Time value of money

Invest $500 10% Balance

Year 1Year 2Year 3

$50.00$55.00$60.50

$550.00$605.00$665.50

$800 in 3 years > $500 today(assuming a 10% rate for money)

Time value of money

Invest $500 20% Balance

Year 1Year 2Year 3

$100.00$120.00$144.00

$600.00$720.00$864.00

Time value of money

Invest $500 20% Balance

Year 1Year 2Year 3

$100.00$120.00$144.00

$600.00$720.00$864.00

$500 today > $800 in 3 years(assuming a 20% rate for money)

Time value of money

Invest $500 20% Balance

Year 1Year 2Year 3

$100.00$120.00$144.00

$600.00$720.00$864.00

$500 * (1+ .20)3 = $864

Future value

FV = PV * (1+ i)n

0 1 2 3 4 56

7

PV

FV

Which is better investment?

Example

How much would a 5-year zero coupon bond face amount $10,000 at 2.5% interest (compounded annually) pay at maturity?

Solution

What is FV ofdollar cost averaging?

(an annuity - $5,000 for 10 years @ 7%)

Law & Valuation 1.2.3 “Future value of annuity”

The end