The process of compounding to determine future values examines what a current monetary investment will be worth at a future specified time. According to Melicher & Norton (2013), the determination of the present value uses the discounting process to determine how much needs to be investment at present to get a targeted future investment. The two processes, therefore, have fundamental differences in them.
The first difference in the processes is the rate used in the calculation of the present and future values. When determining the future values, only the compound interest rate is in use. However, when determining the present values, both the discount rate and the interest rates are in use (Melicher, & Norton, 2013) . The known variables also provide a point of contrast. In the process of computing to determine future values, the present value is known, with the factor being the future value factor. However, in the process of determining the present values, the future value is known; hence the key factor is the present value factor.
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Compounding and discounting are, therefore, the opposites of each other. Melicher, & Norton (2013) posit that i n the first process, we may compound a current present value to know the amount the money will be worth after a specified time in the future, for example 5 years. The resultant value becomes the future value. From this future value, the amount can then be discounted for five years, and it will arrive at the initial amount from the compounding method. The process discounting to determine the present value considers inflation and the purchasing power of the money, whereas the process of compounding to determine future values do not consider inflation. It, however considers its purchasing power. The former is, therefore, more reliable than later.
Reference
Melicher, R. W., & Norton, E. A. (2013). Introduction to Finance: Markets, investments, and financial management . John Wiley & Sons.
