FV= PV (1 + i )N

• FV = Future Value
• PV = Present Value
• i = the interest rate per period
• n= the number of compounding periods

What is the future value of $34 in 5 years if the interest rate is 5%?

• FV= PV ( 1 + i ) N
• FV= $ 34 ( 1+ .05 ) 5
• FV= $ 34 (1.2762815)
• FV= $43.39.

You can go backwards too. I will give you $1000 in 5 years. How much money should
you give me now to make it fair to me? You think a good interest rate would be 6% (You
just made that number up).

• FV= PV ( 1 + i ) N
• $1000 = PV ( 1 + .06) 5
• $1000 = PV (1.338)
• $1000 / 1.338 = PV
• $ 747.38 = PV

O.K. so you give me $ 747.38 today and in 5 years I'll give you $1000. Sound fair? You
will get 6% interest on your money.

Annuities
An Annuity is a bunch of structured payments or equal payments made regularly, like
every month or every week.

You win the lottery. The lottery guy comes to your house and says you have to choose
between getting $ 1,000,000 now in one lump sum, or getting structured payments of $
50,000 a year for the next 22 years. Which do you take?? Or, similarly, let's say you were
injured on the job or whatever and were awarded an annuity of structured payments of
$50,000 a year for the next 22 years. Perhaps you want to sell your annuity (the
payments) to someone and get a lump sum of cash today. Is it worth $1,000,000?

First you have to choose an interest rate. Money is generally worth less in the future,
right? So that $50,000 payment you get in 22 years is not going to be worth as much as it
is today? You know, stuff will be more expensive then, right? So guess an interest rate, in
this case, the rate of inflation for the next 22 years. Lets say 4%. Now, you have to figure
out what is the present value of the $50,000 times 22 years discounted by 4% and then
compare it with the million bucks. There are basically 2 ways to do this.
 • Use a financial calculator.
• Use an annuity table.

Use a financial calculator - The PV of an Annuity.

1. Enter n (the number of compounding periods - in this case the number of years).
Press 22 and then push the N button.
2. Enter i (the interest rate per period - in this case the number of years). Press 4 and
then push the i button.
3. Enter FV (the future value). It is zero. You want to know the Present Value, not
the future value, right? Push 0 and then push the FV button.
4. Enter PMT (the payment). You are not making a payment, you are getting one. So
you have to show a negative number. Press 50000, then the CHS (change sign
button), then push the PMT button.
5. Push the PV (present value) button.
6. Answer = $722,555. This means 22 annual structured payments of 50,000 each is
worth only $722,555 of today's dollars. So you should take the million bucks from
the lottery guy in one lump sum.

Use an annuity table - The PV of an Annuity.

Somewhere in your book, I bet there is a table that looks something like this:

1% 2% 3% 4%
1 00.9901 00.9804 00.9703 00.9615
2 01.9704 01.9416 01.9135 01.8861
3 02.9410 02.8839 02.8286 02.7751
4 03.9020 03.8077 03.7171 03.6299
5 04.8534 04.7135 04.5797 04.4518
6 05.7955 05.6014 05.4172 05.2421
7 06.7282 06.4720 06.2302 06.0021
8 07.6517 07.3255 07.0197 06.7327
9 08.5660 08.1622 07.7861 07.4353
10 09.4713 08.9826 08.5302 08.1109
11 10.3676 09.7868 09.2526 08.7605
12 11.2551 10.5753 09.9450 09.3851
13 12.1337 11.3484 10.6350 09.9856
14 13.0037 12.1062 11.2961 10.5631
15 13.8651 12.8493 11.9379 11.1184
16 14.7179 13.5777 12.5611 11.6523
17 15.5623 14.2919 13.1661 12.1657
18 16.3983 14.9920 13.7535 12.6593
19 17.2260 15.6785 14.3238 13.1339
20 18.0456 16.3541 14.8775 13.5903
21 18.8570 17.0112 15.4150 14.0292
22 19.6604 17.6580 15.9369 14.4511

1. Find this table.

2. On the left, find the number of compounding periods (in this case years) - 22
3. On the top, find the interest rate - 4%
4. Find below where they meet. It says 14.4511
5. Multiply 14.5111 times the Payment - $50,000
6. Answer = $725,555. This means 22 annual structured payments of 50,000 each is
worth only $722,555 of today's dollars. So you should take the million bucks from
the lottery guy in one lump sum.

Perpetuities
are equal payments made regularly, like every month or every year, that go
Perpetuities -
on forever.

You are rich. (Yes, but are you really happy?) You want to start the YOUR NAME HERE
Scholarship at your university. Every year, some student will receive a $1000 scholarship.
You're paying for it. Even after you, your kids and your grandkids are dead, you are still
paying for it. Forever.
The question is....How much money will it cost you. In today's dollars. What is the
present value of this perpetuity. (Hint: starting now and going on forever and ever, you
assume the interest rate at your bank is going to be 3%).
PV (of a perpetuity) = payment / interest rate

Every year the interest you earn is used to pay for the scholarship. The principal in your
bank account doesn't really change year to year.

• PV (of a perpetuity) = payment / interest rate

• PV = $ 1000 / .03
• PV = $ 33,333
So, you put $ 33,333 into the bank. Each year the money earns $1000 interest. That
interest becomes the scholarship.