Quiz 4: Present Value


An equation can be used to calculate the present value of almost any financial security. For example if you receive $100 in one year $150 in two years and $200 in 3 years and at interest at 4% the present value of your payments is the present value of 100 in one year plus the present value of $150 in 2year plus the present value of $200 in 3 year. img If you are evaluating set of payments of F 1 in one year F 2 in two years, and so on out to img in N years where the rate of discount is img This is a present value formula img This is used to calculate the present value of any financial security. In case of a single payment a higher future amount will yield a higher present value also a higher rate of discount or discount factor will yields lower present value. If the rate of discount were smaller say zero percent then the discount factor also would be smaller (1.00) in this case the present value is img Here the present value is p = 104 and future value is 104. Discount is zero.

The amount of money you need to invest today to yield a given future amount. The method of present value is you compare follows of money received or paid at different times. The concept of present value is based on two main ideas 1. How much money you have available at different times by borrowing and services.2.interest is earned on past interest? For example , if you have $100 to pay that you want to save for the future you will deposit in bank account then you can earn a 4 percent annual interest rate. If you deposit $100 in a bank Account for 2 years at 4 percent annual interest rate, in the first year you can earn $4 in first year by interest and have $ 104 at the end of the year. In the second year you can earn $108.16 at the end of the year img The amount by which a future value is divided to obtain its present value, which equal img for an amount to be received or paid in N year, where img is the rate of discount For example: you invest $1000 in a security that pays interest of 8 percent each year. The value of your $1000 investment is img For 10 years your investment has grown to only img

If we invest the value of $1000 in security that pays interest in 8 percent each year you mayn't de too impressed after five years because value of your $1000 investment is img After two years our interest has grown to only img So, we won't be get much on that investment. Here no chance to become a milliner. If we keep our investment for a longer time compounding begins to matter after 25 years our investment is work img After 50 years it is work img If we preferred the long term investment on $1000 than we will become milliners at compound interest so we believe the banking point of view