Compounding
Compounding
is to calculate future value from the present value. Discounting is to calculate the present value
from the future value. Formula for compounding and discounting is given below
Future Value = Present
Value (1+ rate of Interest)n -
Compounding
Future Value = Present
Value (1+ rate of Interest)-n -
Discounting
n= number of
period
Example of Compounding
Mr. A
deposited 20,000 @ 12% in a bank .how much money he will receive after 5 years
Solution
Future Value
= Present Value (1+ rate of Interest)n
= 20,000 (1+.12)5
=20,000 x 1.762
=35,246
Example of Discounting
Mr. A is expected to receive
40,000 in 5 years. Rate of interest is 15%. What is present value of future
cash flows?
Solution
= 40,000 (1+.15)-5
=40,000 x .497
=19,880
