Q. Explain Compound Value Concept?
The Compound Value Concept is used to find out the FV of present money. It is the same as the concept of compound interest, wherein the interest earned in a preceding year is reinvested at the Prevailing rate of interest for the remaining period. Thus, the accumulated amount (principal + interest) at the end of a period becomes the principal amount for calculating the interest for the next period. The compounding technique to find out the FV of present money can be explained with reference to:
1) The FV of a single present cash flow, and
2) The FV of a series of cash flows.
1) FV of a Single Present Cash Flow: the future value of a single cash flow is defined in term of equation as follows: FV = PV (1 + r)n Where, FV = Future value PV = Present value (given) .r = % Rate of interest, and n = Time gap after which FV is to be ascertained.
The above equation explains that the FV depends upon the combination of three variables i.e. the PV, the r, and the n. If anyone of these three variables changes, the FV will also change. There can be an almost infinite number of combinations of these three variables and therefore there can be corresponding infinite number of FVs. For example, one may be interested to find out then FV of Rs. 1,000 at 10% after 7 years or of Rs. 5,000 at 11% after 9 years or Rs. 50,000 at 16% after 3 years and so on. Every time the tedious calculations as per Equation are to be to find out the future value.