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Present Value-FIN6404

Present Value-FIN6404 - Present Value The time value of...

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Present Value The time value of money principle says that future dollars are not worth as much as dollars today. We can compare present and future values with a rather simple equation. (1) This will give you the present value of a single future cash flow (FV) . In fact for ease down the road we will generally use CF instead of FV. Future Value (FV) will be reserved for when we are actually solving for a future value. (For example how much will we have in 5 years). A simple Present Value example follows: What is the present value of \$8,000 to be paid at the end of three years if the correct (risk adjusted interest rate) is 11%? (2) = 8,000/(1.11) 3 = 8,000/1.36 =\$5,849 Note that if you had so desired you could write this equation as (3) PV = CF * (1/(1+r) t ) Which would be: PV = 8,000 * (1/1.11) 3 ) =8,000 * .7312 = \$5,849 The second term in equation 3, (1/(1+r) t ), is known as the present value discount factor or present value interest factor. It is usually abbreviated PVIF(r%, N periods). You can find this number either mathematically or from present value tables. Specifically this is the present value of a dollar and can be

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found on table A-1. (Note the higher the required interest rate, i.e. the more risk, the lower the present value.) Continuing our example, suppose that you were willing to make a loan where you would get \$8,000 back at the end of the third year, and \$10,000 at the end of the fourth year. What is the present value of this?
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