University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

32

Pages:

1
Author:

stud_ice13

Interest is the additional amount paid by a borrower to the lender for the use of an asset, and it causes the value of assets and liabilities to change over time. For example, money deposited in a savings account earns interest, adding to the account balance over time. Conversely, a liability, such as a car loan, accrues interest, increasing the amount the borrower ultimately repays. To evaluate these changes in value, two core financial concepts are used: present value and future value. 1. Present Value (PV): This calculation determines what a future sum of money is worth in today’s terms, accounting for the interest that could be earned over time if invested. PV is particularly useful when comparing the value of future cash flows with current costs or investments. 2. Future Value (FV): This calculation estimates the value of a current asset at a future date, factoring in the accrued interest. FV is helpful when planning for long-term goals or understanding the growth potential of an investment. The concepts apply both to single sums and to series of payments, or annuities. In the case of an annuity, both present and future values help assess the total worth of regular payments made or received over time. Real-World Example: Robert Miles, a maintenance worker, faced a choice after winning a $5 million jackpot: he could receive a $250,000 annuity for 20 years or a lump sum of $3,210,000 upfront. After taxes, this lump sum would be about $2,124,378. This example illustrates how the present value of a future series of payments can be compared to a lump-sum payment received immediately, allowing individuals to make informed financial decisions based on current and future values.