To view a video of present value calculations, go to: http://www.youtube.com/wat

Question

To view a video of present value calculations, go to:

http://www.youtube.com/watch?v=2sXYobpdsUA

Also, view the calculations provided in the following example:

http://educ.jmu.edu/~drakepp/principles/module3/pvanex.html

Please answer questions below, based on the following facts:

If a production machine costs $18,000, and we are able to set up the following payment arrangements with the bank:

Number of payments = 4 (one at the end of each year) Interest Rate = 5%
Amount of each annual payment = $5,000
Questions:

What is the present value of the stream of cash flows (the series of payments)?

Will we be provided with enough purchasing power at the present time to be able to

purchase the machine?

What do you find difficult (if anything) about present value concepts? Did your

background (economics, finance) help you understand current examples of present value

issues?

Does the text do a reasonable job of explaining the role of present value in

Explanation / Answer

1. PV = FV / ( 1 + rate/100)T

PV = 5000/ [ (1 + 5/100)^1 + (1 + 5/100)^2 + (1 + 5/100)^3 + (1 + 5/100)^4]

PV = 5000* 3.54 = $17729.75

2. No, we cannot purchase the machine because the seller won't agree with this deal, PV of payments is less than the present value of machine. Seller would incur a loss if he/she sells the machine.

3. Yes understanding time value of money concept helped a lot in present value studies.

4. Yes, because comparing present cost and discouting future installments one can assess whether a deal is profitable or not for an indvidual or company.

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