When one borrows money from bank, one has to pay more in the future by paying interest.
Interest comes in a variety of forms, compound, simple, etc. Today we will explore simple interest.
If you borrow $100 with an annual interest of 10%, and you are paying back the money after 5 years, calculate how much money you has to pay back.
100 *(1.10)^5 = 161.05
Therefore you owe the bank $161.05.
Here is another example. Assume one person burrowed $x with interest of 10%. They paid the money back 4 years later with $135. How much money did they borrow?
x*(1.10)^4 = 135
x = 135 * (1.10)^-4
x = 92.21
So they borrowed $92.21, 4 years ago.
Like this you can calculate money you borrowed. In this case, the money you borrowed is called Present Value. The money you need to pay back is called Future Value.
For example, find the present value of $100 with interest of 5% 2 years later.
Present Value(PV) = 100 *(1.05)^-2
= 90.70
The PV is $90.70.
For example, find Future value of $100 with interest of 5% 2 years later.
Future Value(FV) = 100*(1.05)^2
= 110.25
The FV = $110.25
Looking at the examples above, you can see that to find present value, you need to multiply by negative power, while to get the future value you need to multiply by positive power.
As a result, future value of money today is greater than present value.
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This article was written for you by Edmond, one of the tutors with SchoolTutoring Academy.