Suppose that you are in the real estate business. You are considering the construction of an office building. The land would cost $50,000 and construction would cost another $300,000. Assume for the moment that a $400,000 payoff is guaranteed. The office building is not the only way to obtain $400,000 one year from now. How much would you have to invest in a government bond (interest rate @ 7%) in order to receive $400,000 at the end of the year?
You would have to invest:
$400,000 X 1/1.07 = $400,000 X .935 = ...
This solution is comprised of a simple explanation of how to calculate net present value.