Question

Can you provide example for this using Financial calculator and explain?

1) What happens to the PV of a set amount to be received in 10 years if your rate of return decreases?

a) The PV increases

2) What happens to the PV of a set amount if the rate stays the same, but compounds more frequently?

a) The PV decreases

3) What happens to the PV of a set amount if the length of time shrinks, but the rate stays the same?

a) The PV decreases

Answer 1

1 Let the future cash flow be $1,000 and rate of return be 10% (the discount rate), now calculate PV as per below;

PV = 1000/(1+10%)^10 - if we are using financial calculator OR

PV = 1000 * PVIF at 10% for 10 years - If we are using Present value table

So, PV = 1000/(1+0.10)^10

= 1000/(1.1)^10

= 1000/2.59

= 386 (Approx.)

Now suppose, discount rate decreases to 8%, so PV in this case,

PV = 1000/(1+0.08)^10

= 1000/(1.08)^10

= 1000/2.16

= 463 (Approx.)

So, decreasing the rate PV will increase.