10/31/2011

Compound Interest Formula

Here we will go through some compound interest formulas , used for the calculations in compounding. The very basic formulas associated with compound interest are these for the future value of money and the present value of money.

Basic Compound Interest Formulas



The future value compounding formula - shows what an investment would be after a certain period (in the future) compounded at a specific rate:

FV = PV(1+i)n
FV - future value
PV - present value
i - interest rate

Exampe: The future value of $100 dollas at 10% annual interest rate after 5 years would be:
FV=100(1+0.10)5 = 100*1.61051 = $161,05

You can easily calculate the future value of and investment with our compound interest calculator

The present value compounding formula - - shows the present value of a future amount of money.

PV = FV/(1+i)n

where
FV - future value
PV - present value
i - interest rate

You can check THIS more detailed explanation of the matter. Now let's see a simple example:
Example: John wants to pay me $1000 after 3 years, if I gave him $800 today. Would it be beneficial for me, if I can receive 7% interest on my money in the bank?

To solve this, we should see what would be the present value of the future payment of $1000 dollars, and see if it is greater than $800. Is so, we will make a profit lending to John.

PV = 1000/(1+0.07)3 = 1000 / 1.225043 = 816.2978768909

So the future value is greater than the amount I would give to John with  $16.28 . This will be my profit if I lens him.

You can read a lot on the matter here.

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