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4. Present value Finding a present value is the reverse of finding a future value. Which of the following is true about finding the present value of cash flows? Finding the present value of cash flows tells you what a cash flow will be worth in future years at a specified rate of return. Finding the present value of cash flows tells you how much you need to invest today se that it grows to a given future ameunt at a specified rate of return. Which of the following investments that pay will \( \$ 5,000 \) in 12 years will have a higher price today 4065800 The security that earns an interest rate of \( 5.50 \% \). The security that earns an interest rate of \( 0.25 \% \), Eric wants to invest in government securities that promise to pay \( \$ 1,000 \) at maturity. The opportunity cost (interest rate) of hoiding the security is \( 13.80 \% \). Assuming that both investments have equal risk and Eric's investment time horizon is flexible, which of the following investment options will exhibit the lower price? An investment that matures in eleven years An investment that matures in ten years Which of the following is true about present value calculations? Other things remaining equal, the present value of a future cash flow decreases if the investment time period increases. Other things remaining equal, the present value of a future cash flow increases if the investment time period increases.

Ask by Estrada Nichols. in the United States
Feb 13,2025

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Answer

1. Finding the present value of cash flows tells you how much you need to invest today so that it grows to a given future amount at a specified rate of return. 2. The security with a 0.25% interest rate will have a higher present value today. 3. The investment maturing in eleven years will have a lower price than the one maturing in ten years. 4. The present value of a future cash flow decreases as the investment time period increases.

Solution

Below are the answers with brief explanations: 1. Finding the present value of cash flows tells you how much you need to invest today so that it grows to a given future amount at a specified rate of return. (The first statement describes computing a future value.) 2. For a future payment of $5,000 in 12 years, the security with the lower interest rate (0.25%) will have a higher price today. (When the discount rate is lower, the present value increases.) 3. With an opportunity cost of 13.80%, the investment that matures in eleven years will have a lower price than the one maturing in ten years. (A longer time horizon means more discounting, reducing the present value.) 4. Other things remaining equal, the present value of a future cash flow decreases if the investment time period increases.

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The Deep Dive

The concept of present value is rooted in the time value of money, a financial principle suggesting that a dollar today is worth more than a dollar in the future due to its potential earning capacity. Historically, this idea was popularized during the Renaissance with the advent of banking systems, and financial calculations have since evolved, enabling investors to assess the worth of future cash flows today, taking into account factors like interest rates and inflation. In the real world, understanding present value is crucial for making smart investment decisions. For example, companies often use present value calculations when assessing the value of future cash flows from projects or investments, allowing for more informed choices about where to allocate resources. Whether you're considering a savings account, bonds, or any investment promising future payouts, calculating the present value helps determine if you're getting a good deal today!

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