Question

Text needs to be at least 350 words Give your own definition of the term present value, and as part of your answer, explain why present values are dependent on interest rates. Would the present value amount be more or less if you compounded more frequently than once a year? Explain in detail why?

Answer 1

Solution:-

Present Value:- Present value (PV) is the current value of a future sum of money. In other words stream of cash flows discounted ata a rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they be earnings or obligations.

As per above definition, the higher the discount rate, the lower the present value of the future cash flows & the lower the discount rate, higher the present value. So we can say that the present value is wholly depend on the rate of interest.

Examples:-

Present value amount is less if we compound more than 1 year.

• When the annual interest rate is 10%, the present value of $1,000 is $751.

• When the annual interest rate is 20%, the present value of $1,000 is $579

• When the annual interest rate is 30%, the present value of $1,000 is $455