subject related to future value and present value Scenario: You are offered $25,

Question

subject related to future value and present value

Scenario: You are offered $25,000 now or $30,000 five years from now with a simple annual rate of 4.5% (0.045).

Which option would you choose ($25,000 now or $30,000 in five years) and why?

a - choose $30,000 in five years because it is worth more than $25,000

b - choose $25,000 now because it will grow to a larger sum in five years

c - choose $30,000 in five years because it is greater than the present value

d - choose either option because I would make the same amount

Explanation / Answer

This question is an application of basic time value of money function, according to which FV = PV *(1 + R)n.

Now in order to answer this question we need to bring both the cashflows to the same time period. Either we compound $25000 for 5 years at 4.5% to compute its FV at year 5 or discount $30000 for 5 years at 4.5% to compute its PV at year 0.

FV ($25000, at t=5) = 25000 *(1 + 4.5%)^5 = 31,154.55

PV ($30000, at t=0) = 30000/(1 + 4.5%)^5 = 24,073.53

Clearly from both the approaches, option of receiving ?$25000 today is more beneficial.

Answer would accordingly be OPTION B

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