The following section presents different examples related to calculating future values based on simple annual interest rates and compounded annual interest rates.
Example 1: Calculate Future Value Using Simple Annual Interest
What is the future value of $1,000 invested today in 5 years assuming 6% simple annual interest rate?
The future value will be calculated using the future value formula using simple interest rate and will equal:
$1,000 * (1+(0.06*5)), or $1,300.
Example 2: Calculate Future Value Using Compounded Annual Interest 1
A bank offers a compounded interest rate of 7% annually. An investor wants to invest $1000 today. What will be the value of the investment in 9 years?
To calculate the value of the investment in the future, the future value formula using a compounded annual interest should be used. Hence, the future value equals:
$1,000*(1+0.07)^9, or $1,838.46.
Example 3: Calculate Future Value Using Compounded Annual Interest 2
Calculate the future value of the investment based on the following data:
X = $500
i = 9% compounded annual interest
n = 3
Using the parameters above, the future value is:
$500 * (1+0.09)^3, or $647.51.
Example 4: Power of Compounded Annual Interest
Calculate the future value of an investment worth $1,000 today in 100 years using both 1% simple annual interest and 1% compounded annually.
Using the simple interest rate future value formula, the future value of the investment is equal to:
$1000 * (1+(0.01*100)), or $2,000.
Using the compounded interest rate future value formula, the future value of the investment is equal to:
$1,000 * (1+0.01)^100, or $2,704.81.
It is important to note that compounded interest results in higher interest compared to the simple interest.
Example 5: Make a Business Decision
An individual wants to purchase a house in 25 years that costs $190,000. If this person invests $150,000 today in an investment account that earns 1% compounded annually, will he/she be able to make the house purchase?
Applying the formula using compounded annual interest, the future value of the current deposit in 25 years will be:
$150,000 * (1+0.01)^25, or $192,364.80.
Therefore, after 25 years, the house can be purchased.
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