Compounding a Cash Flow

Current cash flows can be moved to the future by compounding the cash flow at the appropriate discount rate.

Future Value of Simple Cash Flow = CFo (1+ r)

where

CFo = Cash Flow now r = Discount rate

Again, the compounding effect increases with both the discount rate and the compounding period.

As the length of the holding period is extended, small differences in discount rates can lead to large differences in future value. In a study of returns on stocks and bonds between 1926 and 1997, Ibbotson and Sinquefield found that stocks on the average made 12.4%, treasury bonds made 5.2%, and treasury bills made 3.6%. Assuming that these returns continue into the future, Table 1 provides the future values of $ 100 invested in each category at the end of a number of holding periods - 1 year, 5 years, 10 years, 20 years, 30 years, and 40 years.

Table 1: Future Values of Investments - Asset Classes

Holding Period

Stocks

T. Bonds

T.Bills

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

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