Question

250 words

As you increase the length of time involved, what happens to future values? What happens to present values?

Answer 1

In order to demonstrate the impact of time duration on future and present value, let us consider a sum of $100 in two different situations. In the first situation, let this $ 100 be invested at an interest rate of say 10% for two different tenures, 10 years and 20 years.

Future Value when invested at 10 % for 10 years = 100 x (1.1)^(10) = $ 259.37

Future Value when invested at 10 % for 20 years = 100 x (1.1)^(20) = $ 672.75

As is observable increasing the tenure increases future value of the same amount invested at the same interest rate.

Now consider a sum of $ 100 which comes in either at the end of 10 years or at the end of 20 years. The prevailing interest rate is again assumed to be 10 %

The present value of $100 coming in at the end of 10 years = 100 / (1.1)^(10) = $ 38.55

The present value of $100 coming in at the end of 20 years = 100 / (1.1)^(20) = $ 14.86

As is observable, increasing the tenure reduces the present value of the same amount discounted at the same interest rate.