The future value (FV) represents the worth of a cash flow or a series of cash flows at a specific point in the future. It takes into account the idea that money available today is worth more than the same amount of money in the future due to its potential earning capacity. In other words, a dollar today can be invested and earn interest, making it worth more than a dollar received in the future.
In the world of finance, understanding the time value of money is critical for making informed investment decisions. One key concept is the future value (FV) of cash flows, which helps investors and financial professionals evaluate the worth of their investments over time. In this blog post, we will delve into the meaning of future value, how to calculate it, its importance, and its various applications.
The future value of a single cash flow can be calculated using the following formula:
Let's say you invest $1,000 today (Present Value) at an annual interest rate of 5% (r = 0.05) for a period of 5 years (n = 5). Using the formula above, we can calculate the future value of your investment:
After five years, your initial investment of $1,000 would grow to approximately $1,276.28.
Understanding the future value of cash flows is crucial for various financial decisions, including: