Question

Topic: Managerial Economics

"The higher the rate of interest the lower is the present value. So also the further in the future the amount payable is, the less the present value of the amount".

Please explain the above meaning of this line.

Answer 1

Present Value & Interest Rate
Present value refers to the current value of a future sum of money given a specified rate of return. The concept says an amount of money is not that worth as today in the future due to various reasons including inflation or the rate of return for investment etc. Money saved today may not satisfy the future demand on the same amount of money. The present value of money has an inverse relationship with the interest rate. Since, the present value have a relation with the future, a high interest rate probably suggests lower present value. Receiving an amount of Rs. 10000 is worthier than the same after 5 years.
Depending on the discount rate that is preferred for the present value of money expecting an amount in the future in fixed number of periods, the present value would invest is determined. As the interest rate increase the amount of money invested in the present value decreases. The amount is calculated using the number of years for the investment and the future value. Since the future value of money is almost calculated, the present value of the same can also be estimated. An investor could invest a particular amount for a rate of interest earning the interest up to a period of time. If he waits for investing the same amount for the same years, he may bear opportunity cost. Inflation plays a role in reducing the future value of money. Depending up on the capability of the present value, the interest rate may be at high or at low creating an inverse relationship with the present value of money.