Microsoft Office

Creating Formulas for Financial Applications 16
Calculating interest with continuous compounding
The term continuous compounding refers to interest that is accumulated continuously. In other words, the
investment has an infinite number of compounding periods per year. The following formula calculates the
future value of a $5,000 investment at 5.75 percent compounded continuously for three years:
=5000*EXP(0.0575*3)
The formula returns $5,941.36, which is an additional $0.08 compared to daily compounding.
NOTE
You can calculate compound interest without using the FV function. The general formula to
calculate compound interest is
Principal * (1 + periodic rate) ^ number of periods
For example, consider a five-year, $5,000 investment that earns an annual interest rate of 5 percent, compounded
monthly. The formula to calculate the future value of this investment is
=5000*(1+.05/12)^(12*5)
Future value of a series of deposits
Now, consider another type of investment, one in which you make a regular series of deposits. This type of
investment is known as an annuity.
The worksheet functions discussed in the “Loan Calculations” section earlier in this chapter also apply to
annuities, but you need to use the perspective of a lender, not a borrower. A simple example of this type of
investment is a holiday club savings program offered by some banking institutions. A fixed amount is
deducted from each of your paychecks and deposited into an interest-earning account. At the end of the
year, you withdraw the money (with accumulated interest) to use for holiday expenses.
Suppose that you deposit $200 at the beginning of each month (for 12 months) into an account that pays
4.25 percent annual interest compounded monthly. The following formula calculates the future value of
your series of deposits:
=FV(0.0425/12,12,-200,,1)
This formula returns $2,455.97, which represents the total of your deposits ($2,400) plus the interest
($55.97). The last argument for the FV function is 1, which means that you make payments at the beginning
of the month. Figure 16.14 shows a worksheet set up to calculate annuities. Table 16.4 describes the
contents of this sheet.
ON the CD-ROM
The workbook shown in Figure 16.14 is available on the companion CD-ROM. The file is
named annuity calculator.xlsx.
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