Future Value: Meaning, Examples, and How It Relates to Present Value

Future Value Definition: Future Value is the opposite of Present Value and measures what an investment today is worth in the future based on the Discount Rate, or the targeted/expected annualized return on this investment.

Future Value goes back to the concept of Present Value: Money earned in the future is worth less than money today because you could invest money today and earn more with it in the future (the time value of money).

People often cite inflation or interest rates as the explanation for why future money is worth less than “current money,” and while these do play a role, they are not the real reason why money is worth less today.

The real reason is the ability to invest today and earn more over time.

The Present Value formula takes a value in the future and divides it by (1 + Discount Rate) ^ # Years to determine what it is worth today.

The Future Value formula takes a value today and multiplies it by (1 + Discount Rate) ^ # Years to determine what it will be worth on a future date.

So, if you invest $1,000 today and earn 10% on it per year (compounded), its Future Value in 5 years I $1,000 * (1 + 10%) ^ 5 = $1,610.5.

In Excel, you can use the FV function to estimate this value, but it’s not strictly necessary because the numbers are so easy to calculate.

Investors often use Future Value to make “quick estimates” for deals and compare potential outcomes across their portfolios.

Estimating the “future value” of a company is also a critical part of analyses such as the DCF and LBO model, but in those, it’s normally based on a valuation multiple, such as Enterprise Value / EBITDA, rather than a simple function.

Files & Resources:

• Simple Template for Future Value (XL)

The Future Value Formula

The formula looks like this:

FV = CV * (1 + i) ^ n

• CV = Current Value or Initial Investment Amount
• i = Expected or Targeted Annualized Return (i.e., the Discount Rate)
• n = Number of Years in Holding Period

Note that the “Expected or Targeted Annualized Return” here is not the interest rate; it’s normally the Weighted Average Cost of Capital (WACC) or the Cost of Equity.

If we were working with a bond and calculating bond yields, for example, this Future Value formula would not make sense unless the interest paid accrued to the bond principal (as with PIK Interest).

But interest on bonds and loans is normally paid in cash during the holding period, which means that the investors get back their initial principal at the end and earn a cash percentage on this number each year.

The concept of Future Value makes sense only if the investment itself grows in value during the holding period, such as what happens with companies that perform well or with real estate assets that increase in price.

It is possible to calculate Future Value using an assumption for simple interest rather than compounded interest, but this is a slightly different issue because with either one, the investment itself still grows.

Simple Interest vs. Compound Interest in Future Value

For example, let’s say that we invest $1,000 today and earn 10% on it per year for 5 years.

If we assume compound interest, the Future Value is $1,000 * (1 + 10%) ^ 5 = $1,610.5, following the formula above.

This is because we earn $100, or 10% * $1,000, in the first year, and add this $100 to the $1,000 balance.

Then, in Year 2, we earn 10% of this new $1,100 balance, so 10% * $1,100 = $110, and we add this $110 to the $1,100 to get $1,210.

It keeps going like that until we reach Year 5.

However, with simple interest, the annual gains are calculated based on just the original principal, which remains constant through the holding period.

So, in this example, we would earn $1,000 * 10% = $100 in Year 1, another $100 in Year 2, and so on, and we’d reach $1,500 by Year 5.

Compounding produces a much higher Future Value, and it makes a bigger difference over longer time frames.

The Future Value Function in Excel

One reason to use the built-in FV function in Excel to calculate the Future Value is that it lets you vary the compounding frequency and periods.

You can do this manually as well, but the FV function makes it much easier.

For example, let’s say you’re evaluating a potential investment that will cost you $5,000 in today’s dollars, and you expect annualized returns of ~8% per year over 8 years.

You want these to compound semiannually, or twice per year, which is easy to implement with the FV function in Excel.

Here’s the required setup and the output:

The Excel formula here is as follows:

=FV(RATE, NPER, PMT, -CURRENT VALUE)

=FV(8% / 2, 16, 0, -5000)

We are using 8% / 2 rather than 8% because this is semiannual compounding, so we need to divide the annualized return by 2 to get the 4% that compounds in each half-year period.

The 16 is because we expect to hold this investment for 8 years, and 2 half-year periods in each year means there are 8 * 2 = 16 total periods.

Future Value Function in Real Estate

If you purchase a property and expect that prices will appreciate each year, you can use the Future Value formula to estimate what the property might be worth in several years.

For example, if you buy a property for $1 million today, and its price increases by 8% per year, it will be worth almost $1.5 million in 5 years, as shown below:

Future Value vs. Present Value and Net Present Value

All the concepts are based on the time value of money.

• Future Value takes the current value of an investment and projects what it will be worth in the future based on a targeted or expected annualized return (the Discount Rate).
• Present Value takes the future value of an investment or cash flow and discounts it to what it is worth today based on the Discount Rate.
• Net Present Value equals the Present Value of an investment, i.e., the sum of its discounted future cash flows, minus the “Asking Price” – what you pay upfront for the investment.

NPV is not directly comparable to Future Value because they measure different things: NPV is about determining whether you will make money on an investment, while Future Value simply estimates what an investment might be worth in the future.

It is possible to get a favorable Future Value for an investment but still get a negative NPV.

This normally happens if the “asking price” is far too high and produces an annualized return below the one you are seeking.

For example, let’s say that you could invest $1,000 today and earn 10% per year on it, so that it’s worth $1,611 in 5 years.

If you discount this $1,611 back 5 years to its Present Value today at this 10% Discount Rate, its Present Value is $1,000.

However, the “asking price” is $1,200.

So, the owner of this asset will not sell it for $1,000 – they want $1,200.

In this scenario, the Net Present Value is negative because $1,000 – $1,200 = ($200).

The problem is that your expectations for the annualized returns do not align with the seller’s.

For the NPV to be 0%, the Discount Rate would have to be closer to ~6%, which is far below the 10% annualized return you are targeting.