Question

Explain how the practice of calculating the present value of expected future cash flows can assist you in your next salary negotiation; or perhaps discuss how you would use (in the future or have used in the past) NPV calculations of future personal income earning potential when evaluating the decision to pursue an advanced academic degree.

Answer 1

Solution:-

In all walks of life that directly or indirectly involve financial decision making, we must always consider the impact of time on those decisions. The value of money doesn't stay the same with time due to variety of factors such as changes in economic fundamentals , inflation, interest rates, etc and while taking any financial decision, an individual must always factor that in.

Same goes for salary negotiations. Let's take an easy example to understand this- If the employer wants a job candidate to consider lesser base salary against long term financial incentives which would be received after 3 years, the employee must consider the present value of those future cash flows with the option of receiving higher base salary at present, so that the correct decision can be taken.

Similarly, lot of companies hold back a certain part of employee's salary and pay it at the end of the year. While negotiating with such employers, the candidates should take into effect the time value of money and calculate the present value of those year-end payments to understand the true offer the employer is making.

The same principle goes for analyzing the benefit of taking an education degree. The present costs of course fee should be compared with the present value of increase in future earnings because of the degree. This discounting of future expected cash flows is very important so that the results are truly accurate and the correct decision can be taken by the prospective student.