Introduction to Corporate Finance - Coursera
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  • Introduction
  • Corporate Finance - An Introduction
  • Time Value of Money
    • Discounting
    • Compounding
    • Annuity
    • Growing Annuity
    • Perpetuity
    • Growing Perpetuity
    • Taxes
    • Inflation
  • Interest Rates
    • APR and EAR
    • Term Structure
  • Discounted Cash Flow
    • Decision Making
    • Free Cash Flow
    • Forecast Drivers
    • Forecasting Free Cash Flow
    • Sensitivity Analysis
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  • Note

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  1. Time Value of Money

Compounding

PreviousDiscountingNextAnnuity

Last updated 4 years ago

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Compounding is the process of moving CFs forward in time.

The value of a CF at a future point in time is called its future value. Future Value FVt(CFi)FV_t(CF_i)FVt​(CFi​) denotes the future value of CFiCF_iCFi​ at a future timestamp t.

Simple Example

How much money will we have four years from today if we save $100 a year, beginning today, for the next 
three years, assuming we earn 5% per annum?

First, place the CFs on a timeline:

Then, find their future values at timestamp 4, using compounding:

Then, aggregate the future values. We get $452.564.

Therefore, the future value four years from today of saving $100 starting today for the next three years at 5% per annum is $452.56.

Note

We can use a combination of compounding and discounting, allowing us to aggregate CFs at any timestamp.