Question

Discuss how interest rates (r) and time (t) play a role in the calculation of future value or present value.

Answer 1

Interest rate are the rate of Earning in a particular time period on the investment made.

Interest and time plays a very important role in calculation of Present and furture value.

For calculation of Present value we use the interest and time to discount the cash flows using the annuity factors or interest factors depending upon the cash flows.

A present value equation is denoted as follows

For a non cumulative cash flow = Cash flow * PVif(int, years)

For a cumulative cash flow = Cash flow * PVif(int, years)

There is also an inverse relationship between the Present value and Interest or time.Higher will be the Interest and time, lower will be the present value and vise-versa.

On the other hand Future value means compunding the interest with the cash flows for a particular period of time. Hence to calculate the future value of the cash flow again the interest and time plays a vital role.

But the future value and Interest or time has a direct relationship. Higher the interest and time higher will be the future value. Since we compound the interest so with every compunding the future value increases.

Without the Interest rate and time there will be no concept of Present or future value as because without compunding or dicounting trhe cash flow will always remain. No upward or downward fall.