Present Value of Amounts Due
Tommy John is going to receive $740,000 in three years. The current market rate of interest is 4%.
a. Using the present value of $1 table in Exhibit 8, determine the present value of this amount compounded annually. Round to the nearest whole dollar $ 657,857
b. Why is the present value less than the $740,000 to be received in the future? The present value is less due to Inflation over the 3 years.
a. Net Present Value = Amount to be received x Discounting Factor
Net Present Value = Amount x [1 / (1+discounting %)Years ]
Net Present Value = $740,000 x [ 1 / (1+4%)3]
Net Present Value = $740,000 x 1 / 1.124864
Net Present Value = $740,000 x 0.888996
Net Present Value = $657,857 (rounded off to whole number)
b. Inflation. Money as of today is relatively worth more than money after a particular period of time owing to inflation and other factors like earning capacity of the amount during this period of time. For example, $100 today is worth more than $100 after a year as the $100 of today can be invested (say at 4%) and become $104 at the end of the year.
Tommy John is going to receive $740,000 in three years. The current market rate of interest is 4%.