1.2.1.1. 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 today’s funds will be worth in the future depends on the interest rate at which they will grow. 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 invested right now increase in value.
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 its issuing company’s growth, making educated guesses about how that company’s profits, expenses, and assets will grow over time can help you estimate a security’s worth as an investment.
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 on the company’s previous five years’ income statements, you’ve come up with the following data, including the average increase in certain categories each year.
|
ABC Company (from previous years’ 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 |