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If a cash flow is compounded more frequently than annually, then intrayear compounding is being used. To adjust for intrayear compounding, an interest rate per compounding period must be found as well as the total number of compounding periods.
The interest rate per compounding period is found by taking the annual rate and dividing it by the number of times per year the cash flows are compounded. The total number of compounding periods is found by multiplying the number of years by the number of times per year cash flows are compounded.
For instance, suppose someone were to invest $5,000 at 8% interest, compounded semiannually, and hold it for five years.
The interest rate per compounding period would be 4%, ( 8% / 2 ).
The number of compounding periods would be 10, ( 5 × 2 ). |
To solve, find the future value of a single sum looking up 4% and 10 periods in the Future Value table.
FV = PV(FVIF)
FV = $5,000(1.480)
FV = $7,400
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