What is an example of present value concept?
If you win the lottery, and they tell you will get 20,000 a year for 30 years. What is that worth in present dollars?
$36000.00
To determine the present value of the future cash flows, we need to discount them to account for the time value of money. In this case, we need to calculate the present value of receiving $20,000 every year for 30 years.
To calculate the present value, we use a discount rate that represents the rate of return that we could alternatively earn on our money if we invested it. Let's assume a discount rate of 5% for this example.
To calculate the present value of each future cash flow, we use the formula:
Present Value = Future Cash Flow / (1 + Discount Rate)^n
Where:
- Future Cash Flow is the amount of money we will receive in the future ($20,000 in this case)
- Discount Rate is the rate at which we discount future cash flows (5% or 0.05)
- n is the number of periods in the future when the cash flow is received (each year for 30 years)
Using the formula, we can calculate the present value of each cash flow and then sum them up to find the total present value.
Present Value (Year 1) = $20,000 / (1 + 0.05)^1 = $20,000 / 1.05 = $19,047.62
Present Value (Year 2) = $20,000 / (1 + 0.05)^2 = $20,000 / 1.1025 = $18,113.69
...
Present Value (Year 30) = $20,000 / (1 + 0.05)^30 = $20,000 / 2.6533 = $7,540.10
Now, sum up all the present values:
Total Present Value = Present Value (Year 1) + Present Value (Year 2) + ... + Present Value (Year 30)
Total Present Value = $19,047.62 + $18,113.69 + ... + $7,540.10 = $364,461.48
Therefore, the present value of receiving $20,000 every year for 30 years, assuming a discount rate of 5%, is approximately $364,461.48.