Financial: Present Value, Future Value
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There is an aspect of financial presentations that many students find
confusing, namely the use of two terms: present value
and future value.
If we look at a financial problem
that states:
"At the start we have $4000 which we invest at 5% simple interest for 3 years,
what is the amunt of interest earned and how much will we have at the end of the 3 years?"
then most students understand that the interest earned is given by
I = PRT so we will earn 4000*0.05*3 which amounts
to $600, and that at the end of the 3 years our original investment is returned to
us so that "at the end" we will have $600 $4000 = $4600.
On the other hand, if we find a problem that states:
With a present value of $4000, and a simple interest rate of 5% for 3 years,
what is its future value?"
many students, at least until they understand the concepts, seem to get confused
by the terms present and future.
Present value means the value at the start of the financial situation.
Future value means the value at the end of the financial situation.
In particuar, present value does NOT necessarily mean the value at this moment,
and future value does NOT necessarily mean the value at some
time in our future. For example, it is perfectly reasonable to say:
"If you had been given $4000 four birthdays ago and you had invested it at 5%, what
was the total value of that investment at your last birthday?"
In that case, the present value is $4000, the value at the start,
and the future value is $4600, the value at the end of the situation.
There is no question about the value today. The future value is actuall in the past.
Or we could find a question such as
"You will be given $4000 on your next birthday. If you invest that amount at 5%
what will be the value of the investment three birthdays later?"
In that case the present value is in the future.
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©Roger M. Palay Saline, MI 48176 March, 2017