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Which of the following formulas correctly calculates the future value of an ordinary annuity when additional equal investments are made at the end of each period for \(n\) periods at an interest rate \(r\) per period?
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10. Time Value of Money
Time Value of Money Equations
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The process for converting present values into future values is called:
A
Amortization
B
Compounding
C
Discounting
D
Depreciation
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Understand the concept of 'present value' and 'future value': Present value refers to the current worth of a sum of money, while future value refers to the value of that sum at a later date after interest or growth has been applied.
Learn the definition of 'compounding': Compounding is the process of calculating the future value of a present sum by applying interest over time. It involves reinvesting interest earned so that it also earns interest.
Differentiate compounding from other terms: Amortization refers to spreading payments over time, discounting is the reverse of compounding (converting future values into present values), and depreciation refers to the reduction in the value of an asset over time.
Recognize that compounding is the correct term for converting present values into future values, as it involves applying interest to grow the value over time.
Apply the formula for future value using compounding: \( FV = PV \times (1 + r)^n \), where \( FV \) is the future value, \( PV \) is the present value, \( r \) is the interest rate per period, and \( n \) is the number of periods.
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