Time Value of Money in Finance: practice question
A client of Orlund Capital deposits $5,000.00 into an account paying 7.00% interest compounded annually. Assuming no withdrawals, the account's value at the end of four years is closest to:
- 6,125.22
- 6,400.00
- 6,553.98
Show answer and explanation
Correct answer: C
Working: FV = 5,000 × 1.07^4 = 5,000 × 1.310796 = 6,553.98 (check: 5,000 × 1.07^3 = 6,125.22; simple interest 5,000 × (1 + 0.07 × 4) = 6,400.00)
Explanation: C is correct: annual compounding for four years gives FV = 5,000 × 1.07^4 = 6,553.98. A applies the growth factor for only three years (5,000 × 1.07^3 = 6,125.22). B uses simple interest, 5,000 × (1 + 0.07 × 4) = 6,400.00, which ignores interest earned on interest.
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