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Present
value is the value today of an amount that would exist
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in
the future with a stated investment interest rate r (called the
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discount
rate) for a period of n.
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PV=Future $ / [(1+r)n]
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An
example:
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You
are promised to receive $10,000 in 20 years. At an interest rate
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r=5%,
what’s the value of that $50,000?
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Answer: PV=$10,000/[(1+5%)20]=$3,769
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You
can also use Table A.3 on page 450 in the textbook. Note 5% for
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20
years has a present value of 0.3769. That means $1 in 20 years at
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5%
discount rate has a present value of $0.3769. Then the present value
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of
receiving $10,000 in 20 years is 0.3769*10000=$3,769.
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