Compounding tells us what an investment made today is going to be worth tomorrow.
For example, imagine you have 20m and are going to invest it in the bank at say a 1% interest rate. How much money are you going to have in say five years’ time? It’s compounding that gives us the answer.
At the end of one year, you are going to have 20m x (1 + 1%) = 20.2m. At the end of two years, you are going to have 20m x (1 + 1%) x (1 + 1%), and so on for five years.
Excel compounding challenge
The challenge right now is to create a formula in Excel that will tell you how much money you will have in five years’ time. In Excel, you need to enter something like “=20*(1+1%)^5”. Notice you need to find the little “^” (‘hat’) symbol on your keyboard. That symbol means “to the power of” and what we’re doing there is multiplying our original investment by (1 + 1%) five times.
Compounding in Excel: the answer
We are starting slowly (it will get harder!) but please click if you would like to download an Excel spreadsheet that will allow you to check your answers to the compounding course challenge above.
Return to the Excel financial modelling course extract