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What is Future Value?

2017-08-12T07:30:10+00:00

The term 'Future Value' is included in the Corporate Finance edition of the Financial Dictionary. Get yours now on amazon in ebook or paperback format. Read more here...

Future Value refers to a current asset’s anticipated value at a given specific date of the future. Such a forecast will be dependent on the rate of growth rate that the company assumes over time. As an example, a company may assume a certain guaranteed rate of growth. This would allow them to state that a $10,000 investment they make now will have a value of $100,000 twenty years from now. This would have the FV of the original $10,000 investment at $100,000. This equation takes for granted that the rate of growth will be approximately consistent and constant. It also assumes that the upfront payment is an untouched one throughout the life of the literal investment in question.

Such a Future Value calculation permits managers and analysts alike to anticipate with hopefully some accuracy the profits they can forecast earning in comparing varying investments. The weakness is that the quantity of growth which the investment generates cannot be predicted with one hundred percent certainty. Still, the returns on the investment if it were sunk into stocks versus a new product launch or other revenue accruing project will likely be vastly different from one another, which mean that the accountants will stay busy extrapolating multiple base case scenario possibilities.

It can be quite complex to accurately ascertain the future value of a given asset. This of course varies per the asset class. Such FV calculations assume that the growth rate will remain consistently stable. This is easy to determine with great accuracy when analysts are considering money put into a fixed rate of interest CD or savings account. Investments they make in securities such as stocks will provide a higher degree of volatility and fluctuating rate of return. This makes it exceedingly difficult to prognosticate with accuracy. Where the core idea is concerned though, compound and simple interest rates reflect the easiest to understand examples of utilizing a FV calculation.

These future value calculations might be compiled in two different ways, depending on the interest accruing. Look at the simple interest calculation approach. The formula for when the base case assumes simple interest is FV equals Initial principle times the result of one plus the interest rate multiplied by time in years.

It is always most illuminating to look at a tangible example on challenging concepts such as this one. Consider a $100,000 investment that the firm keeps in a simple time deposit CD account that yields five percent on a simple annual interest payment basis. In this scenario, the future value of the $100,000 would be $100,000 times (one plus .05 times five) for a final result of $125,000.

It becomes more challenging when compounded interest is taken into consideration. Under the compounding interest base case, the rate has to be reapplied on every year’s cumulative account balance. Using the same example as above, if the investment in its first year realizes a five percent interest, this is $5,000 in interest. The next year, the total account value would be base of $105,000 before interest begins to accrue. Now the five percent rate would be applied to the $105,000 instead of the old $100,000 initial total. At five percent interest again, this would yield an interest dollar amount of $5,250. The calculations continue as such until the final year is reached. This means that the formula for investment earnings on a compounded interest basis is Future Value equals Initial investment times the final result of one plus the interest rate raised to the power of the time value.

The term 'Future Value' is included in the Corporate Finance edition of the Financial Dictionary. You can get your copy on amazon in Kindle or Paperback version. See more details here.