Question

How would a decrease in the interest rate effect the present value of a lump sum, single amount problem (all other variables remain the same)?

Multiple Choice

• Increase the time needed to save.

• Increase the present value.

• Change the future value.

• Decrease the present value.

Answer 1

The present value is computed as shown below:

= Future value / (1 + r)ⁿ

If we will decrease the interest rate, it will result in to lowering of denominator which will ultimately lead to increase in the present value. The same is illustrated as shown below:

For example: Present value of $ 1,000 to be received after 1 year at 10% rate of interest

= $ 1,000 / 1.10

= $ 909.09

Present value of $ 1,000 to be received after 1 year at 9% rate of interest

= $ 1,000 / 1.09

= $ 917.43

As can be seen when we reduce the rate of interest, it lead to increase in the present value.

So, the correct answer is option of Increase the present value.

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