Welcome back, and this is going to be another very important section, as Exel has some amazing tools
and formulas available for finance functions like present value and future value.
But before we go to those Excel formulas, let us first revise our time value of money concept.
The time value of money concept is very simple.
And it means says that Dollar one today has more value than dollar one after some time, maybe five
years.
And why is that so?
Because of the inflation, there are three factors and one of them is inflation.
With inflation, it means that if you can purchase something for one dollar today, it won't be available
for purchase after one year or two years or five years or whatever time.
Why?
Because because of the inflation, the prices would increase.
So if you can purchase something for one dollar today, you may need to say one dollar and twenty cents
to purchase it after five years.
Now, this one dollar is called the present value.
And one point two for this conversion that I have just done will be called the future value for one
dollar today.
So what you can do with one dollar today, you will need one point two dollars added five to that to
achieve the same thing that will be called 1.0 will be called future value for one dollar today.
Now, the next thing that we need to do as accounting and finance professional is to be able to convert
present value to future value.
And that is the next task that we are going to do.
And for that, let's say we have ten thousand dollars today in our bank and in the market.
We are having 12 percent interest rate.
So I'm depositing my money.
Ten thousand dollars into the bank and bank is offering 12 percent to me in response to that as an interest.
So what will be the value of my ten thousand dollars after some time?
So you must be thinking that I have completely ignored inflation.
I'm coming to the interest for this calculation.
Well, this is the simplest thing to start with.
I will definitely be coming back to inflation as well.
So what will happen is that after one year, my ten thousand dollars will be multiplied, but 100 percent,
the 100 percent.
I mean that I'm just repeating the original amount, nothing extra, 100 percent.
If I can just do it for you can see that I'm just repeating the original amount.
Plus there will be some additions and additions will actually be 12 percent.
So I can just read the formula here.
There will be 12 percent.
So.
That would be the value of my money of ten thousand dollars today after one year.
So the future value at your fund for my ten thousand dollars will be eleven thousand two hundred.
No, I will just copy paste this formula to all other cells.
And you can see that each year the value of the money is increasing.
And at year five, the value of my ten thousand dollars today will be seventeen thousand six twenty
three dollars.
So that will be the future value of ten thousand dollars at year five.
Now this process of going from zero to onwards is called compounding.
So basically we are adding compound interest and that is in the process of converting present value
to future value.
Likewise, you can also go backwards.
You can start with sixteen thousand six twenty three dollars and 42 cents at year five and you can repeat
the same process in the reverse order.
So in the last example, you are going from zero to one.
So we were adding the interest rate.
I was multiplying that with hundred plus percent.
Now this time I will be dividing that one hundred percent and I will be adding 12 percent into it for
the purpose of the discounting as well.
So I would be, you know, a person enter here and you can see that I have converted the value out of
five to four and I will just copy paste this formula to all the different years here.
And you can see that I can calculate back from year five to zero as well.
So now I can convert my present value to future value and I can convert the future value back to present
value.
This process of going present to future is called compounding, and this process of coming back from
future to present is called discounting.
And no, we were only using 12 percent here, which I mentioned as interest rate.
And definitely I was giving the example of bank will only interest is relevant.
But if we are talking about the practical life we are, there is inflation as well in the market and
we are there as risk as well in the investment.
We call it discount rate.
So rather than interest rate, we call a discount rate because the discount rate is a combination of
all of these three interest and inflation and risk.
So all of this combined together.
So we will be using the discount rate for conversion from present to the future and future to the present.
And the formula that I have used here is very simple.
If I can just repeat this formula here for you, what I have done, what I've done is that I have said
future value will be equal to present value in two.
If I close the record, that will be one, one is four hundred percent plus our artists for rate of
interest and power that will be and whatever the number of years.
So if you are working for a year one, the power will be one.
If you are going to year to the power will be two.
If you are going to your the power will be three.
I have not used the power here because I was using the relative reference of Excel.
Don't worry about that.
I will just show you now.
So basically, if I have to come to your five directly from years, you do what I will says and I will
say ten thousand dollars multiplied by.
One plus point, one, two, that is 100 percent or you can say 100 plus, 100 percent plus 12 percent,
and then I will take the power of five.
And you can see that I've come directly to the year five or you can use it in the reverse order.
The same formula can be used.
The same question here can be used in the reverse order to get to the present value from the future
value.
So that is the best equivalent of present value and future value concept.
I hope that was helpful.