Time Value of Money says that the value of a unit of money will be changed in the future. Put simply, the value of a rupee today will have decreased in the future. The whole concept is about the present value and future value of money. There are two methods used to ascertain the value of money at different times, namely capitalization and discount. The method of combination used to know the future value of current money. On the contrary, it Discount a way to calculate the present value of future money.
The compounding useful for knowing the future values ??of the cash flow, at the end of the particular period, at a defined rate. Contrary to this, discounting is used to determine the present value of the future cash flow, at a specific interest rate. Here, in this article, we have described the differences between capitalization and discount.
|Sense||The method used to determine the future value of the current investment known as compounding.||The method used to determine the present value of future cash flows known as Discounting.|
|Concept||If we invest money today, what will be the amount we will get in a future date.||What should be the amount we have to invest today to get a specific amount in the future.|
|Use of||Compound interest rate||Discount rate|
|Known||Present value||Future value|
|Factor||Future value factor or complication factor||Present value factor or discount factor|
|Formula||FV = PV (1 + r) ^ n||PV = FV / (1 + r) ^ n|
Definition of Compounding
To understand the concept of capitalization, first of all, you need to know the term future value. The money you invest today will grow and earn interest on it, after a certain period, which will automatically change its value in the future. Hence the value of the investment in the future known as future value. The aggregation refers to the interest remuneration process both on the principal amount and on the interest accrued by reinvesting the entire amount to generate more interest.
The compound is the method used to find out the future value of the current investment. The future value can be calculated by applying the compound interest formula which as below:
Where n = number of years R = rate of return on investment.
Discounting the process of converting the future amount into its present value. Now you may be wondering what the present value is? The current value of the specified future value known as the present value. The discounting technique allows you to ascertain the present value of future cash flows by applying a discount rate. The following formula used to know the present value of a future sum:
Where 1, 2, 3, … ..n represents future years FV = cash flows generated in different years, R = Discount rate
To calculate the present value of the single cash flow and the annuity, the following formula should be used:
Where R = Discount rate n = number of years
also you can use the discount factor to get the present value of a future amount simply by multiplying the factor with the future value. For this purpose, it is necessary to refer to the table of current values.
Key differences between the compound and the actualization
The following are the main differences between compounding and discount stores:
- The method uses to know the future value of a present quantity known as compounding. The process of determining the present value of the amount to be received in the future known as a discount.
- The combination uses compound interest rates while discount rates are used in discounts.
- Compacting a current amount means what we will get tomorrow if we invest a certain amount today. Discounting the future amount means that we should invest today to get the specified amount tomorrow.
- The future table of value factors refers to the calculation of future value in case of capitalization. Conversely, in the discount, the present value can be calculated with the help of a Present value factor table.
- In the composition, the amount of the present value already specified. On the other hand, the future value given in case of discounting.
Compounding and discounting are simply opposite to each other. Compounding converts the present value to a future value and the discount converts the future value to a present value. So, we can say that if we cancel the capitalization it will become a discount. The compound factor table and the discount factor table are taken into account for the rapid calculation of the two. In the table, you will find the factors, concerning different rates and periods. The factor is directly multiplied by the amount to arrive at the present or future value.