Present Value-Single Multiple Cash Flows
The Present Value concept is also known as discounting technique. In this approach, the money experienced in some future date will be worth lesser now at the present date because the corresponding interest is lost during the period. Given a positive rate of interest, the present value of future amount will always be less, and thus this procedure is known as discounting.
Present Value - Single Cash Flows
We will first look at discounting a single cash flow or amount. The cash flow can be discounted back to a present value by employing a discount rate that accounts for the factors such as present consumption preference, risk, and inflation. In converse manner, cash flows in the present can be compounded to arrive at an anticipated future cash flow.
The present value of a single cash flow can be written as follows:
|
PV = FVn / (1 + i)n
|
|
PV
|
the present value (or initial principal)
|
|
FVn
|
future value at the end of n periods
|
|
i
|
the interest rate paid each period
|
|
n
|
the number of periods
|
This means that if investor know what a future payment will be, when it will be made and what interest rate that investor would be paid to achieve comparable future payments. Investor can compute that payment's present value. Fortified with this basic formula, investor can compute a present value quite easily if investor know what the future payment will be or it is anticipated to be, when it will be made and the discount rate applied.
To illustrate: What would investor be inclined to give up to have $1,200 a year from now? Stated in our evaluation lexicon investor ask: What is the present value of a $1,200 cash flow to be experienced one year from now? Presuming an appropriate discount rate of 20%, investor can apply our present value formula:
|
PV = FV / (1 + discount rate)
= $1,200 / (1 + .20)....
= $1,200 / 1.2 ..............
= $1,000.......................
|
Notice that the higher the discount rate, the smaller the present value. This inverse relationship speculates the reality that an amount in the future is worth less today if present investment opportunities promise high returns (discount rate).
Simplifying present value computations
|
Investor can simplify present value computations by employing a table that demonstrates present value of $1 discounted at i percent for n periods. Please refer the attached tables:
|
FV = (1 + i)n
future value of $1 compounded at i percent for n periods
|
PV = 1/(1 + i)n
present value of $1 discounted at i percent for n periods
|
|
FV = SUM [i=1 to n] (1 + i)n
future value of $1 deposited at the end of each of n periods
compounded at i percent
|
PV = SUM [i=1 to n] 1/(1 + i)n
present value of $1 deposited at the end of n periods
discounted at i percent
|
Employing the present value table, what is the present value of $2,500 in 8 years, a discount rate (the opportunity cost of other investments) of 12%? of 6%? Answers: $2,500*.4039 = $1,009.70 (12%); $2,500*.6274 = $1,568.50 (6%).
There are a couple of facts mentioned below:
> The lower the discount rate, the more valuable are future amounts -- in a low-inflation economy,
|
Present Value - Multiple Cash Flows Present Value of Multiple Cash Flows
We come across many cases where investor has to find out the present value of series of multiple cash flows. There are two ways investor can compute present value of multiple cash flows. Either an investor discount back individual cash flow at a time or an investor can just compute the present values individually and add them up.
Example:
Suppose if an investor want $10,000 in one year and $15,000 more in two years. If an investor can earn 8% on this money, how much an investor need to invest today to exactly earn this much in the future? In other sense, what is the present value of two cash flows at 8%.
Present value of $15,000 in 2 years at 8 percent is:
$15000/1.082 =$12860.082
Present value of $100 in 1 year at 8% is:
$10,000/1.08 =$9259.259
The total present value is :
$12860.082+$9259.259=$22119.341
Present Value-Single Multiple Cash Flows - Online Tutoring - Assignment Help
We at Expertsmind.com offer Present Value-Single Multiple Cash Flows homework help, Present Value-Single Multiple Cash Flows free tutorials and assignment help and time value of money based question's answers by help of qualified and experienced finance tutors. We make easy Present Value-Single Multiple Cash Flows assignments and homework for you with conceptual theory and by solving each kind of problems following a tricky approach.
ExpertsMind.com - Present Value-Single Multiple Cash Flows Assignment Help, Present Value-Single Multiple Cash Flows Homework Help, Present Value-Single Multiple Cash Flows Assignment Tutors, Present Value-Single Multiple Cash Flows Solutions, Present Value-Single Multiple Cash Flows Answers, Time Value of Money Assignment Tutors