Answer the following questions:
1. Would you prefer to have $100 today or $100 one year from now? Why?
2. How can compounding build wealth over time?
3. How can compounding increase debt over time?
4. Based on your responses to Questions 2 and 3, how can compounding both build wealth and increase debt? Is compounding a power or a curse?
Q1. Would you prefer to have $100 today or $100 one year from now? Why?
Based on the two offers above, I would prefer $100 from now and not $100 a year from now. The reason for me choosing the $100 today is based on the concept of time value of money. Within the one year period, the $100 taken today can be invested to earn interest and the potential of earning power. On the other hand, the $100 given one year from now has no potential to earn interest over time and it can never be invested (Cornett, Adair & Nofsinger, 2013). In addition, the $100 given one year from now may have a reduced value that makes it less worth with its true value when the same amount is taken. Taking $100 today eliminates the possible risks involved in taking the same amount of money in one year time.
Q2. How can compounding build wealth over time?
Compounding has the potential of building wealth over time since it affects the time value of money, such as the interest rates over time and these interest rates are added to the principal amount to increase its value. For example, if the $100 invested such that the order receives 110% per year, the value of the $100 will be $110 in one year period. When the same amount of money is invested for several years to come, the income will grow as explained in the chart below.
Q3. How can compounding increase debt over time?
Apart from increasing the value of wealth, increases the value of debts over time since it constantly increases the value of the principal amount. This means that the value of debt will continue to grow on the yearly basis at a faster rate in the same magnitude it grows in wealth creation.
Q4. Based on your responses to Questions 2 and 3, how can compounding both build wealth and increase debt? Is compounding a power or a curse?
Based on the above responses, compounding is not a curse, but a power by which companies can increase their wealth by issuing more shares. In addition, compounding will make more lenders have more loans from the company that when paid in full will increase their wealth tremendously (Cornett, Adair & Nofsinger, 2013).
Cornett, M., Adair, T., & Nofsinger, J. (2013). M:Finance. McGraw-Hill/Irwin; 2 edition
