{"id":29842,"date":"2024-08-04T22:58:04","date_gmt":"2024-08-05T03:58:04","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/?post_type=biws_kb&#038;p=29842"},"modified":"2024-12-16T23:40:00","modified_gmt":"2024-12-17T04:40:00","slug":"future-value","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/finance\/future-value\/","title":{"rendered":"Future Value: Meaning, Examples, and How It Relates to Present Value"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Future Value: Meaning, Examples, and How It Relates to Present Value<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/future-value\/#The_Future_Value_Formula\">The Future Value Formula<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/future-value\/#Simple_Interest_vs_Compound_Interest_in_Future_Value\">Simple Interest vs. Compound Interest in Future Value<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/future-value\/#The_Future_Value_Function_in_Excel\">The Future Value Function in Excel<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/future-value\/#Future_Value_Function_in_Real_Estate\">Future Value Function in Real Estate<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/future-value\/#Future_Value_vs_Present_Value_and_Net_Present_Value\">Future Value vs. Present Value and Net Present Value<\/a><\/li><\/ul><\/nav><\/div>\n\n<blockquote><p><strong>Future Value Definition:<\/strong> Future Value is the <em>opposite<\/em> of Present Value and measures <em>what an investment today is worth in the future<\/em> based on the Discount Rate, or the targeted\/expected annualized return on this investment.<\/p><\/blockquote>\n<p>Future Value goes back to the concept of <a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/present-value\/\" target=\"_blank\" rel=\"noopener\">Present Value<\/a>: Money earned <em>in the future<\/em> is worth less than money today because you could invest money today and earn more with it in the future (<a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/time-value-of-money\/\" target=\"_blank\" rel=\"noopener\">the time value of money<\/a>).<\/p>\n<p>People often cite inflation or interest rates as the explanation for why future money is worth less than \u201ccurrent money,\u201d and while these do play a role, <strong>they are not the real reason why money is worth less today.<\/strong><\/p>\n<p>The real reason is the ability to invest today and earn more over time.<\/p>\n<p>The Present Value formula takes a value in the future and divides it by (1 + Discount Rate) ^ # Years to determine what it is worth today.<\/p>\n<p>The Future Value formula takes <em>a value today<\/em> and <em>multiplies it<\/em> by (1 + Discount Rate) ^ # Years to determine what it <em>will be worth<\/em> on a future date.<\/p>\n<p>So, if you invest $1,000 today and earn 10% on it per year (compounded), its Future Value in 5 years I $1,000 * (1 + 10%) ^ 5 = $1,610.5.<\/p>\n<p>In Excel, you can use the <strong>FV<\/strong> function to estimate this value, but it\u2019s not strictly necessary because the numbers are so easy to calculate.<\/p>\n<p>Investors often use Future Value to make \u201cquick estimates\u201d for deals and compare potential outcomes across their portfolios.<\/p>\n<p>Estimating the \u201cfuture value\u201d of a company is also a critical part of analyses such as the <a href=\"https:\/\/mergersandinquisitions.com\/dcf-model\/\" target=\"_blank\" rel=\"noopener\">DCF<\/a> and <a href=\"https:\/\/mergersandinquisitions.com\/lbo-modeling-test\/\" target=\"_blank\" rel=\"noopener\">LBO model<\/a>, but in those, it\u2019s normally based on a <a href=\"https:\/\/breakingintowallstreet.com\/kb\/valuation\/valuation-multiples\/\" target=\"_blank\" rel=\"noopener\">valuation multiple<\/a>, such as Enterprise Value \/ EBITDA, rather than a simple function.<\/p>\n<h3><strong>Files &amp; Resources:<\/strong><\/h3>\n<ul>\n<li><a href=\"https:\/\/youtube-breakingintowallstreet-com.s3.us-east-1.amazonaws.com\/Finance\/BIWS-Future-Value-Template.xlsx\" target=\"_blank\" rel=\"noopener\">Simple Template for Future Value (XL)<\/a><\/li>\n<\/ul>\n<h2><span class=\"ez-toc-section\" id=\"The_Future_Value_Formula\"><\/span><strong>The Future Value Formula<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>The formula looks like this:<\/p>\n<p><strong><em>FV = CV * (1 + i) ^ n<\/em><\/strong><\/p>\n<ul>\n<li>CV = Current Value or Initial Investment Amount<\/li>\n<li>i = Expected or Targeted Annualized Return (i.e., the Discount Rate)<\/li>\n<li>n = Number of Years in Holding Period<\/li>\n<\/ul>\n<p>Note that the \u201cExpected or Targeted Annualized Return\u201d here is <em>not<\/em> the interest rate; it\u2019s normally the <a href=\"https:\/\/mergersandinquisitions.com\/wacc-formula\/\" target=\"_blank\" rel=\"noopener\">Weighted Average Cost of Capital (WACC)<\/a> or the Cost of Equity.<\/p>\n<p>If we were working with a bond and calculating <a href=\"https:\/\/breakingintowallstreet.com\/kb\/debt-equity\/bond-yield\/\" target=\"_blank\" rel=\"noopener\">bond yields<\/a>, for example, this Future Value formula would not make sense unless the interest paid accrued to the bond principal (as with <a href=\"https:\/\/breakingintowallstreet.com\/kb\/leveraged-buyouts-and-lbo-models\/pik-interest\/\" target=\"_blank\" rel=\"noopener\">PIK Interest<\/a>).<\/p>\n<p>But interest on bonds and loans is normally paid in cash during the holding period, which means that the investors get back their initial principal at the end and earn a cash percentage on this number each year.<\/p>\n<p>The concept of Future Value makes sense only if the <em>investment itself grows in value<\/em> during the holding period, such as what happens with companies that perform well or with real estate assets that increase in price.<\/p>\n<p>It is possible to calculate Future Value using an assumption for <strong>simple interest<\/strong> rather than <strong>compounded interest<\/strong>, but this is a slightly different issue because with either one, the investment itself still grows.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Simple_Interest_vs_Compound_Interest_in_Future_Value\"><\/span><strong>Simple Interest vs. Compound Interest in Future Value<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>For example, let\u2019s say that we invest $1,000 today and earn 10% on it per year for 5 years.<\/p>\n<p>If we assume <strong>compound interest<\/strong>, the Future Value is $1,000 * (1 + 10%) ^ 5 = $1,610.5, following the formula above.<\/p>\n<p>This is because we earn $100, or 10% * $1,000, in the first year, and add this $100 to the $1,000 balance.<\/p>\n<p>Then, in Year 2, we earn 10% of this new $1,100 balance, so 10% * $1,100 = $110, and we add this $110 to the $1,100 to get $1,210.<\/p>\n<p>It keeps going like that until we reach Year 5.<\/p>\n<p>However, with simple interest, the <strong>annual gains are calculated based on just the original principal<\/strong>, which remains constant through the holding period.<\/p>\n<p>So, in this example, we would earn $1,000 * 10% = $100 in Year 1, another $100 in Year 2, and so on, and we\u2019d reach $1,500 by Year 5.<\/p>\n<p>Compounding produces a much higher Future Value, and it makes a bigger difference over longer time frames.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"The_Future_Value_Function_in_Excel\"><\/span><strong>The Future Value Function in Excel<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>One reason to use the built-in FV function in Excel to calculate the Future Value is that it lets you <strong>vary the compounding frequency and periods<\/strong>.<\/p>\n<p>You can do this manually as well, but the FV function makes it much easier.<\/p>\n<p>For example, let\u2019s say you\u2019re evaluating a potential investment that will cost you $5,000 in today\u2019s dollars, and you expect annualized returns of ~8% per year over 8 years.<\/p>\n<p>You want these to compound <strong>semiannually<\/strong>, or <strong>twice per year<\/strong>, which is easy to implement with the FV function in Excel.<\/p>\n<p>Here\u2019s the required setup and the output:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29843 size-full\" title=\"Future Value - Excel Setup\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/08\/04225602\/Future-Value-01.jpg\" alt=\"Future Value - Excel Setup\" width=\"1784\" height=\"826\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/08\/04225602\/Future-Value-01.jpg 1784w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/08\/04225602\/Future-Value-01-300x139.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/08\/04225602\/Future-Value-01-1024x474.jpg 1024w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/08\/04225602\/Future-Value-01-768x356.jpg 768w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/08\/04225602\/Future-Value-01-1536x711.jpg 1536w\" sizes=\"(max-width: 1784px) 100vw, 1784px\" \/><\/p>\n<p>The Excel formula here is as follows:<\/p>\n<p>=FV(RATE, NPER, PMT, -CURRENT VALUE)<\/p>\n<p>=FV(8% \/ 2, 16, 0, -5000)<\/p>\n<p>We are using 8% \/ 2 rather than 8% because this is <strong>semiannual compounding<\/strong>, so we need to divide the annualized return by 2 to get the 4% that compounds in each half-year period.<\/p>\n<p>The <strong>16<\/strong> is because we expect to hold this investment for 8 years, and 2 half-year periods in each year means there are 8 * 2 = 16 total periods.<\/p>\n<div class='code-block code-block-2' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/04\/24164120\/adv-fm-tile.png\" alt=\"PowerPoint Pro\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Master Financial Modeling for Investment Banking With <strong>BIWS Core Financial Modeling<\/strong><\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Become a financial modeling pro<\/h4>\n              <p>158 videos, detailed written guides, Excel files, quizzes, and more<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 10+ detailed global case studies<\/h4>\n            <p>These include both the theory and the practical applications<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Prepare for your internship or full-time job<\/h4>\n            <p>Gain the skills you need to \u201chit the ground running\u201d on Day 1\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/core-financial-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Core-Financial-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div><\/div>\n\n<h2><span class=\"ez-toc-section\" id=\"Future_Value_Function_in_Real_Estate\"><\/span><strong>Future Value Function in Real Estate<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>If you purchase a property and expect that prices will appreciate each year, you can use the Future Value formula to estimate what the property might be worth in several years.<\/p>\n<p>For example, if you buy a property for $1 million today, and its price increases by 8% per year, it will be worth almost $1.5 million in 5 years, as shown below:<\/p>\n<p><img decoding=\"async\" class=\"aligncenter wp-image-29844 size-full\" title=\"Future Value - Simple Example for a Property\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/08\/04225629\/Future-Value-02.jpg\" alt=\"Future Value - Simple Example for a Property\" width=\"856\" height=\"378\" srcset=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/08\/04225629\/Future-Value-02.jpg 856w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/08\/04225629\/Future-Value-02-300x132.jpg 300w, https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/08\/04225629\/Future-Value-02-768x339.jpg 768w\" sizes=\"(max-width: 856px) 100vw, 856px\" \/><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Future_Value_vs_Present_Value_and_Net_Present_Value\"><\/span><strong>Future Value vs. Present Value and Net Present Value<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>All the concepts are based on the <strong>time value of money<\/strong>.<\/p>\n<ul>\n<li><a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/future-value\/\" target=\"_blank\" rel=\"noopener\"><strong>Future Value<\/strong><\/a>\u00a0takes the current value of an investment and projects what it will be worth in the future based on a targeted or expected annualized return (the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/discount-rate\/\" target=\"_blank\" rel=\"noopener\">Discount Rate<\/a>).<\/li>\n<li><strong>Present Value<\/strong> takes the future value of an investment or cash flow and <strong>discounts<\/strong> it to what it is worth today based on the Discount Rate.<\/li>\n<li><a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/net-present-value\/\" target=\"_blank\" rel=\"noopener\"><strong>Net Present Value<\/strong> <\/a>equals the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/present-value\/\" target=\"_blank\" rel=\"noopener\">Present Value<\/a> of an investment, i.e., the sum of its discounted future cash flows, minus the \u201cAsking Price\u201d \u2013 what you pay upfront for the investment.<\/li>\n<\/ul>\n<p><strong>NPV<\/strong> is <em>not<\/em> directly comparable to Future Value because they measure different things: <a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/net-present-value\/\" target=\"_blank\" rel=\"noopener\">NPV<\/a> is about determining whether <em>you will make money on an investment<\/em>, while Future Value simply estimates what an investment might be worth in the future.<\/p>\n<p>It is possible to get a favorable Future Value for an investment but still get a negative NPV.<\/p>\n<p>This normally happens if the \u201casking price\u201d is far too high and produces an annualized return below the one you are seeking.<\/p>\n<p>For example, let\u2019s say that you could invest $1,000 today and earn 10% per year on it, so that it\u2019s worth $1,611 in 5 years.<\/p>\n<p>If you discount this $1,611 back 5 years to its Present Value today at this 10% Discount Rate, its Present Value is $1,000.<\/p>\n<p><strong>However, the &#8220;asking price&#8221; is $1,200.<\/strong><\/p>\n<p>So, the owner of this asset will not sell it for $1,000 \u2013 they want $1,200.<\/p>\n<p>In this scenario, the <a href=\"https:\/\/breakingintowallstreet.com\/kb\/finance\/net-present-value\/\" target=\"_blank\" rel=\"noopener\">Net Present Value<\/a> is negative because $1,000 \u2013 $1,200 = ($200).<\/p>\n<p><strong>The problem is that your expectations for the annualized returns do not align with the seller\u2019s.<\/strong><\/p>\n<p>For the NPV to be 0%, the Discount Rate would have to be closer to ~6%, which is far below the 10% annualized return you are targeting.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Future Value is the opposite of Present Value and measures what an investment today is worth in the future based on the Discount Rate, or the targeted\/expected annualized return on this investment.<\/p>\n","protected":false},"featured_media":0,"template":"","class_list":["post-29842","biws_kb","type-biws_kb","status-publish","hentry","kb_category-finance"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/29842","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=29842"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}