**« **|** **1 | 2 | 3 | 4 | 5 | **6** | 7 | 8 | 9 | 10 | 11 | 12 | **»**

## Time Value of Money Part VI

**Future Value Formula – Compounding on the Drums**

After a stressful day at the office, I find there’s nothing more soothing that playing a twenty minute drum solo on my drum set in the basement. There’s just something about letting out some aggression on a crash cymbal or snare drum that leaves me feeling a little more peaceful after the fact (it probably has about the opposite effect on anyone else who has to listen). I’ve played drum set since I was about 12 years old and picked up guitar soon after. It’s always been my dream to tour around the country in a rock band so for this small business financial management example, I think it’ll be fun to dream big when applying our new future value formula.

Let’s say that we were part of a famous band that just made their farewell tour throughout the world. Since we had sold out shows all over, we made a ton of cash and are planning to retire from all music in five years to live on a tropical beach. Since we just made $5,000,000 each from the last tour, we want to see how much we’ll have in five years and if that’s enough to retire on (let’s say interest rates are 3%). From the first compound interest post, we learned how to calculate how much something will be worth two years in the future. For this problem, we’ll apply the same concept in the future value formula that we can apply to any problem.

**Rocking Out in General**

Before we get into the specifics of this example, we’ll write out the future value formula in more general terms and then apply it to this problem. To find out how much a certain value is in the future, we just need a couple things to figure it out (three things to be exact). We need to know how much money we initially have to invest, what the interest rate we can save is and how many years we have to save. Then, we can take those three values and put them in the future value formula below:

Future Value = Present Value x ( 1 + Interest Rate ) ^ Number of Years

To find out how much money you’ll have in the future, you’ll need to take the present value (the money you have today) times 1 plus your savings account’s interest rate to the power of the number of years that you’ll have the money in the account. I know that this is a mouthful, but hopefully when we apply it to the next problem it makes some more sense.

**Using the Future Value Formula – The Tour To an Early Retirement**

As we talked about in the last section, we need to know how much money we have today ($5,000,000), the interest rate we can save at (3%) and the number of years that we have to save the money (5 years). As in the previous post, we could solve by multiplying the money we have today by 1 plus the interest rate five times since we are able to save for five years. This is shown below:

Since 1 plus the interest rate = (1 + 3%) = 1.03

$5,000,000 x 1.03 x 1.03 x 1.03 x 1.03 x 1.03 = $5,796,370

The quicker way that we could solve it is by putting the stuff we know into the future value formula listed in the section above. To do this, we’ll substitute in the numbers that we know into the equation below and solve with a calculator.

Future Value = Present Value x ( 1 + Interest Rate ) ^ Number of Years

Future Value = $5,000,000 x (1 + 0.03) ^ 5 = $5,796,370

**Key Takeaways: **To find out how much something will be worth in the future, all we need to know is how much money we have now, what the interest rate is that we can save at and how many years we have to save. Once we have this information, we just have to put the stuff we know in the future value formula to find out the how much we’ll have in the future (the future value):

Future Value = Present Value x ( 1 + Interest Rate ) ^ Number of Years

In the next lesson, we’ll use this equation to find the present value by using future values.

Test Your Knowledge: Future Value Formula

**To Next Lesson: Present Value Equation**

**« **|** **1 | 2 | 3 | 4 | 5 | **6** | 7 | 8 | 9 | 10 | 11 | 12 | **»**