Copyright © 2015, 2011, and 2007 Pearson Education, Inc. 1 Chapter 10 Compound Interest and Inflation Section 3 Present Value and Future Value

Copyright © 2015, 2011, and 2007 Pearson Education, Inc. 2 Future Value and Present Value Future value – amount available at a specific time in the future; amount available after an investment has earned interest Present value – amount needed today so the desired amount will be available when needed

Copyright © 2015, 2011, and 2007 Pearson Education, Inc. 3 Use Tables to Calculate Present Value Find the interest rate per compounding period (i) Find the total number of compounding periods (n) of the investment Use the Present Value of a Dollar Table to find the appropriate value Use the formula to find present value

Copyright © 2015, 2011, and 2007 Pearson Education, Inc. 4 Formula for Present Value Present value (PV) = Future value × Table value

Copyright © 2015, 2011, and 2007 Pearson Education, Inc. 5

6 Example Betty Clark needs to replace two pumps at her gas station in 3 years at an estimated cost of $12,000. What lump sum deposited today at 5% compounded annually must she invest to have the needed funds? How much interest will she earn?

Copyright © 2015, 2011, and 2007 Pearson Education, Inc. 7 Example (cont) Present value = $12,000 × = $10, Step 1 5% compounded for 3 periods

Copyright © 2015, 2011, and 2007 Pearson Education, Inc. 8 Example (cont) Step 2 Interest earned = $12,000 – $10, = $ Step 3 Check answer by finding future value of an investment of $10,366.08, at 5% compounded annually for 3 years.

Copyright © 2015, 2011, and 2007 Pearson Education, Inc. 9 Example (cont) Use compound interest table. Future value = $10, × = $12,000.09

Copyright © 2015, 2011, and 2007 Pearson Education, Inc. 10 Example Radiux Inc. wishes to partner with a Korean company to purchase a satellite in 3 years. Radiux plans to make a cash down payment of 40% of its anticipated $8,000,000 cost and borrow the remaining funds from a bank. Find the amount Radiux should invest today in an account earning 6% compounded annually to have the down payment needed in 3 years.

Copyright © 2015, 2011, and 2007 Pearson Education, Inc. 11 Example (cont) Find the down payment to be paid in 3 years. Down payment =.40 × $8,000,000 = $3,200,000 Use table with 6% and 3 periods

Copyright © 2015, 2011, and 2007 Pearson Education, Inc. 12 Example (cont) Present value = $3,200,000 × = $2,686,784 Radiux must invest $2,686,784 today at 6% interest compounded annually to have the required down payment of $3,200,000 in 3 years.