Question

2. Discuss what would happen to a future value if you increase the rate “r.” Also, what will happen to the present values? Suppose you deposit a large sum in an account that earns a low interest rate and simultaneously deposit a small sum in an account with a high interest rate. Which account will have the larger future value?

Answer 1

Discuss what would happen to a future value if you increase the rate “r.” Also, what will happen to the present values? Suppose you deposit a large sum in an account that earns a low interest rate and simultaneously deposit a small sum in an account with a high interest rate. Which account will have the larger future value?

Solution:

1. What would happen to a future value if you increase the rate “r.”?

=>Formula: A=P(1+r)^N .

The above formula shows that r. ie. Rate of interest is a function of finding the future value by multiplying it with the present value. This as “r” increases, if rate of interest/ return increases, the future value will also increase and the person will get more returns.

2. What will happen to the present values?

=>I if you have to find Present value from future cash flows ie. P= A/(1+r), present value will reduce as much as “r” will increase.

3. Suppose you deposit a large sum in an account that earns a low interest rate and simultaneously deposit a small sum in an account with a high interest rate. Which account will have the larger future value?

=>There is no specific answer to this question. The answer will depend upon taking different values for Principle and interest rate. For example we invest $100 at 10% interest rate for 10 years we will receive $200 after 10 years but if we invest $500 at 5% return for 5 years, we will receive $625 after 5 years. So answer cannot be fixed until the absolute values are fixed.