Compounding

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 $FV_t(CF_i)$ denotes the future value of $CF_i$ 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.