Question

What is present value analysis and how is it useful in economic decision making?

Answer 1

Present Value -

Present value in Economics, is the current value of a future sum of money. It can also be described as a stream of cash flows when we are given a certain rate of return. The Present Value concept tells us that an amount of money today is worth more than that same amount in the future. This is basically assumed by keeping in mind the factors of inflation and an increase in overall purchasing power of people with time.

Use in economic decision making -

Primarily, present value is used to determine the feasibility of an investment by taking into account any interest this investment might earn.

Calculation of Present Value follows the equation -

FV = future value, r = rate of return, and, n = number of periods

Hence, the concept of present value is important in understanding that the money which is not being spent today could be expected to lose value in the future by some the margins of an implied annual rate, which could be inflation or the rate of return if the money was invested.