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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{ 5 comments… read them below or add one }
Helo there.. I just want to mention to u that the i = 3.7% per annum in example 1 that u have given is misleading. i punch all the value in the calculator and cant seem to find the answer. the actual value to be punch for I= o.o37 . THis is to those who didnt know.
Fv= 10000x(1+0.037)power 15=RM17245.72
Ans
1.107179.44
2. 23.83
3. US1.38
Hi Fatduck
You are the first and only person who do the exercise.
You’ve got the right answer for no.1 and 2.
The correct answer for No. 3 is US$1.62
Think logically, if US dollar depreciates, you will get more US dollars from the lower exchange rate.
However, since you are the only respond I got, please provide your mailing address and I will post the prize to you. (use the contact form if you don’t have my email)
Thanks..mzfoo@tm.net.my
I get the answer for Q1 and 2. But my answer for Q3 is US$1.89. That mean my answer is wrong. So can you show me the method or culcalation to get the answer US$1.62?
Thanks.
1USD = RM3.34
Found out how much RM3.34 depreciates across 8 months.
Then divide the value with RM5 to find how much USD you can have.
5/[3.34*(1-0.01)^8] = $1.38