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Present Value Concept and Calculating Present and Future Values

1. In two to three paragraphs, explain why the concept of present value is so important for corporate finance and is often the very first topic taught in any finance class.

2. Calculate the future value of the following:

a. $600 if invested for five years at a 3% interest rate
b. $400 if invested for three years at a 5% interest rate
c. $1100 if invested for seven years at an 11% interest rate
d. $900 if invested for ten years with a 0% interest rate

3. Calculate the present value of the following:

a. $2200 to be received three years from now with a 5% discount rate
b. $950 to be received five years from now with a 11% interest rate
c. $2150 to received two years from now with a 24% interest rate
d. $145,000 to be received eight years from now with a 7% interest rate.

4. Suppose you are to receive a stream of annual payments (also called an "annuity") of $9000 every year for three years starting this year. The discount rate is 6%. What is the present value of these three payments?

5. Suppose you are to receive a payment of $5000 every year for three years. You are depositing these payments in a bank account that pays 2% interest. Given these three payments and this interest rate, how much will be in your bank account in three years?

Solution Preview

1. In two to three paragraphs, explain why the concept of present value is so important for corporate finance and is often the very first topic taught in any finance class.

In today's time, individuals and businesses are confronted with a choice of paying for a purchase today or at a later date. If other things are the same, it is advisable to pay later as cash can be invested somewhere to earn interest. So, money has value over time.

Present value is today's worth of a payment (or payments) to be received in the future. It is the value today of a future payment or series of payments, discounted at the appropriate discount rate.

Present value concept is important in corporate finance as the value of money keeps changing because of interest rates and inflation. It provides us with a platform to compare different cash flows, as cash flow after two years cannot be compared with the cash flow today. Present value method is used to evaluate different financial projects because it gives them a common platform for ...

Solution Summary

This solution discusses the importance of present value. It also depicts the methodology to determine present and future values of single cash flow/annuities. Formula, calculations and answers are provided.

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