Question

1) Please explain what is present value, and come up with one example of the present value application in real life.

2) What happens to present value when you increase the discount rate?

3) Please contrast compounding and discounting.

Answer 1

Answer-

1) Present value is the current value of a future money or a set of cash flow calculated at a specified rate of return. It is a concept which tells that the value of money today is more than the same amount in future.

For example- If a person receives $50,000 today and can earn a rate of return at 5% per year, the $50,000 receiving today will be more than receiving $50,000 at the end of 5 years.

2) As the discount rate increases, the present value of the future money decreases which means they are inversely proportional to each other.

3) Compounding is utilized to decide the future estimation of a investment made in the present whereas discounting is utilized to figure the current estimation of the cash flow that is to come later on.