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M2B Financial Decision Making

Here are several resources that talk about the time value of money and how to perform net present value calculations - EconEd, Study Finance, Discounted Cash Flow. Net present value is often used to inform investment decisions. To perform the calculation, you can follow the formulas as they are presented in the readings or you can simply multiplying the future sum by the appropriate discount factor using the Net Present Value Table.

Please perform the following kinds of calculations, and write a short report describing what you did, showing your figures, and the results that you obtained.

You may use an Excel spreadsheet in order to perform the necessary computations for this question.

Suppose your bank account will be worth $4,200.00 in one year. The interest rate (discount rate) that the bank pays is 5%. What is the present value of your bank account today?
Suppose you have two bank accounts, one called Account A and another Account B. Account A will be worth $3,800.00 in one year. Account B will be worth $6,500.00 in two years. Both accounts earn 5% interest. What is the present value of each of these accounts? What is the combined present value of the two accounts?
Suppose you just inherited an oil well. This oil well is believed to have three years' worth of oil left before it dries up. Here is how much income this oil well is projected to bring you each year for the next three years:
Year 1: $125,000

Year 2: $258,000

Year 3: $310,000

Compute the present value of this stream of income using a discount rate of 7%. Remember, you are calculating the present value for a whole stream of income, i.e. the total value of receiving all three payments (how much you would pay right now to receive these three payments in the future). Your answer should be one number - the present value for this oil well at a 7% discount rate.

Solution Preview

1. Suppose your bank account will be worth $4,200.00 in one year. The interest rate (discount rate) that the bank pays is 5%. What is the present value of your bank account today?

$4000

2. Suppose you have two bank accounts, one called Account A and another Account B. Account A will be worth $3,800.00 in one year. Account B will be worth $6,500.00 in two years. Both accounts earn 5% interest.

What is the present value of each of these accounts? A 3619; B 5896

What is the combined present value of the two accounts? 9515

3 Suppose you just inherited an oil well. This oil well is believed to have three years worth of oil left before it dries up. Here is how ...

Solution Summary

This provides the different ways in which net present value can be calculated given the future value. It includes the use of formulas, tables, differing discount rates, single and multiple periods, and unequal payments.

$2.19