Introduction to Corporate Finance

PART 1: INTRODUCTION

The following example illustrates how you might use the concept of future value to evaluate an

investment in a bank savings account.

An easy way to visualise how time value of money problems work is by drawing a time line like the

one shown in Figure 3.1. A time line is a simple diagram that illustrates the value of a single cash flow

or a series of cash flows as of a particular date. Figure 3.1 demonstrates that if you invest $100 today

(time 0) at 6% interest, in five years (time 5), the future value of the initial $100 will grow to $133.82.

time line
A graphical representation of
cash flows over a given period
of time

You have an opportunity to invest $100 cash in a

bank savings account that pays 6% annual interest.

You would like to know how much money you will

have at the end of five years.

Substituting PV = $100, r = 0.06, and n = 5 into

Equation 3.1 gives the future value at the end of year 5:

FV = $100 × (1 + 0.06)^5 = $100 × (1.3382)

= $133.82

Your account will have a balance of $133.82 at

the end of the fifth year, so your investment grew by

$33.82.

example

FIGURE 3.1 FUTURE VALUE OF $100 INVESTED FOR FIVE YEARS AT 6% ANNUAL INTEREST

This figure illustrates how $100 invested today grows to $133.82 over five years if the annual interest rate is 6%. The time

line at the top shows the initial deposit as well as the accumulated value after five years. The lower left portion of the figure

shows how to calculate the future value using a calculator. Keystrokes will vary from one calculator model to another. The

lower right portion of the figure shows how to calculate the future value using Excel.

Formula B4: =FV(B3,B2,0,B1)

Future value $133.82

Interest rate 6%

5

–$100

Number of periods

Present value

Input

Solution

–100

5

6

PV

N

I

CPT

FV

133.82

Function

Row

Column

Calculator Spreadsheet

End of year

PV = $100

FV = $133.82

0 1 2 3 4 5

1

2

3

4

5

A B