05 Dec 2007 | Comments |
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Time Value of Money: Computing the Value of Single Sum Investment
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In order to be smart and calculative in personal finance matters, understanding the time value of money is an essential part of the learning process.
Starting today, I will be posting a series of computation method related to time value of money on every Wednesday. Now, we will start with learning the calculation of the value of single sum investment.
Common Problems
- You have RM10,000 in a fixed deposit account, giving 3.7% return annually. If you don’t cash out the interest earned, how much if the total money accumulated after 15 years?
- Ali borrowed RM5,000 from a loan shark 5 months ago. He agreed to pay compounded interest of 3% per month, calculated based on total amount owed. But Ali never made any payment until now. How much should the loan shark claim from Ali?
Theory
Before I learn the theory of time value of money (TVM), I used to create spreadsheet using Microsoft Excel to automate the repetitive calculations. Now, save yourself the trouble. Use this formula:
FV (Future value) = future value of investment at the end of period
PV (Present value) = present sum of money set aside for the investment
i = rate of interest
n = number of periods
Solutions
Example 1:
You have RM10,000 in a fixed deposit account, giving 3.7% return annually. If you don’t cash out the interest earned, how much if the total money accumulated after 15 years?
PV = RM10,000
i = 3.7% per annum
n = 15 years
FV= ?
Using scientific calculator, substitute the values into the formula
FV = RM17245.72
The easier way is to use a financial calculator. Try this online future value calculator.
Example 2:
Ali borrowed RM5,000 from a loan shark 5 months ago. He agreed to pay
compounded interest of 3% per month, calculated based on total amount
owed. But Ali never made any payment until now. How much should the
loan shark claim from Ali?
PV = RM5,000
i = 3% per month
n = 5 months
FV= ?
Substitute the values into the formula, you will get
FV = RM5796.37
You should never mess with a loan shark.
Exercise
1. A unit trust agent told you that Fund A give a return of 10% per annum. If you invest RM50,000 now, how much would you expect the total fund value of your investment after 8 years?
2. The current inflation rate is about 3.5% per annum. Now you pay RM10.80 for a cup of Starbucks coffee. How much would it costs when you retire after 23 years?
3. Let’s assume the US dollar is depreciating at a constant rate of 1% per month. Now, USD1 equals to RM3.34. After 8 months, how much US dollar can you get from RM5.00?
Post your answer in the comment section. The first commenter who got the all right answers will get a special 3D birthday card sponsored by Pigeon Card.
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