Future Value
In terms of the exam, there are two primary time value of money concepts that you’ll need to know, the simplest of which is known as future value. This is the concept that the value of funds in the future will be (or should be) more than it is today, based on the ability to earn at least a minimal amount of interest. How much more the funds are worth depends on the interest rate at which the original amount grew. Future value is one of the most basic premises in investing and underlies what everyone reading this book should hope to do for their clients—make what they have in the present grow into something bigger.
When you are analyzing different aspects of a company, determining future value can be extremely helpful. Since the value of a stock or bond issue in the future often depends on the company’s growth, making educated guesses about how a company’s profits, expenses, and assets will grow over time can help you estimate a security’s investment worthiness.
For example, let’s say you’re trying to decide whether to advise a client to invest in ABC Company. Based on the research you’ve done, especially comparing the previous five years’ income statements, you’ve come up with the following data, including the average increase in certain categories each year.
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ABC Company (from previous year’s financial filings) |
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|
Income |
$10,000,000 |
Increases 2% annually, on average |
|
Expenses |
$4,000,000 |
Increases 5% annually, on average |
|
Profit |
$6,000,000 |
|
|
Assets |
$1,000,000 |
Increases 1% annually, on average |
|
Debts |
$1,000,000 |
Increases 3% annually, on average |
Since your client is investing for a retirement that is 10 years into the f