InvestorQ : How does the regular size of contribution impact the present value and the future value of the cash flows?
Abhisha Yadav made post

How does the regular size of contribution impact the present value and the future value of the cash flows?

Answer
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Bhavika Nehru answered.
1 year ago


Let us start off by taking a base case scenario wherein the annual contribution of Rs.2000 in a bond paying 8% over a 10 year compounding is considered. Here are assuming annual compounding. What will the present value and the future value of the cash flows? Consider the table below:

Present Value Calculator (For a Series of cash flows)

Enter the type of cash flow that you are discounting =

GA

[S=Simple;

A=Annuity;

GA=Growing Annuity;

P=Perpetuity;

GP=Growing Perpetuity]

Enter the dollar amount of the cash flow =

? 2,000.00

For S: Enter the single cash flow

For A and P: Enter the cash flow each period

For GA and GP: Enter the current year's cash flow]

Enter the number of years for the cash flow =

10

For S: Specify the year of the cash flow

For A and GA: Enter the number of years for annuity

For P and GP: Leave blank

Enter the annualized discount rate to use on cash flows =

8.00%

Enter the annualized discount rate

Enter the expected growth rate in the cash flow =

0%

Leave blank for S, A and P

Enter the annualized growth rate for GA and GP

Specify the number of compounding periods per year =

1

If semi-annual enter 2, if monthly enter 12 ….

Output for Present Value and Future Value

Discount Rate per period =

8.00%

Number of periods =

10

Present Value of Cash Flow(s) =

? 13,420.16

Future Value of Cash Flow(s) =

? 28,973.12

In the above instance, the present value and the future value of the cash flows are based on annual investment of Rs.2000 at a yield of 8% over a period of 10 years with annual compounding. The total contribution of Rs.20,000 over a 10 year period has a future value of Rs.28,973 and a present value of Rs.13,420 as the future flows get discounted. Now to understand the impact of size of contribution, let us increase this monthly contribution to Rs.3000. check the table below…

Present Value Calculator (For a Series of cash flows)

Enter the type of cash flow that you are discounting =

GA

[S=Simple;

A=Annuity;

GA=Growing Annuity;

P=Perpetuity;

GP=Growing Perpetuity]

Enter the dollar amount of the cash flow =

? 3,000.00

For S: Enter the single cash flow

For A and P: Enter the cash flow each period

For GA and GP: Enter the current year's cash flow]

Enter the number of years for the cash flow =

10

For S: Specify the year of the cash flow

For A and GA: Enter the number of years for annuity

For P and GP: Leave blank

Enter the annualized discount rate to use on cash flows =

8.00%

Enter the annualized discount rate

Enter the expected growth rate in the cash flow =

10%

Leave blank for S, A and P

Enter the annualized growth rate for GA and GP

Specify the number of compounding periods per year =

1

If semi-annual enter 2, if monthly enter 12 ….

Output for Present Value and Future Value

Discount Rate per period =

8.00%

Number of periods =

10

Present Value of Cash Flow(s) =

? 33,231.76

Future Value of Cash Flow(s) =

? 71,744.88

As we can see in the above table, the increase in annual contribution by 50% has increased the present value and the future value by over 2.5 times. This is the power of compounding principle on which the future value and present value concepts are based.