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I have few questions related to present value and future value.
Is it true that:
1) Present value can be used by the investors for the purpose of borrowing and investment. What I mean is that the investors used the present value to see how much they have to borrow or invest today to get a certain amount of liability or income in the future?
2) The purpose of calculating the present value for borrowing is to find out how much money we have to borrow today to get a specific amount of liability in the future. For instance, IF the investors know that they will be paying a liability of $100,000 to be paid within one year’s time for borrowing the money then they can find out the present value for how much they have to borrow today?
3) For example, if we are paying a liability of $100,000 to be paid in one year’s time at interest rate of 12% then we need to borrow a principal amount of $107,142 but in real life this is not a problem because we would be known the principal amount plus interest by the banks.
4) The purpose of calculating the PV is that so we can record the balances at their present value in our Financial statements (that’s it?)
5) Similarly, the purpose of calculating the present value for investment is to find out how much money we have to invest today to get a specific amount of income in the future. For instance, IF the investors know that they will be earning an income of $120,000 to be paid within one year’s time then they can find out the present value for how much they have to invest today?
6) For example, if we are expecting an income of $120,000 to be received in one year’s time at interest rate of 10% then we need to invest a principal amount of $109,090 but in real life this is not a problem because we would be known the principal amount plus interest earned by the banks.
1) Yes, present value can be used by investors for the purpose of borrowing and investment.
2) The purpose of calculating the present value for borrowing is indeed to find out how much money needs to be borrowed today to meet a specific liability in the future.
3) I Agree
4) The purpose of calculating present value is not solely for recording balances in financial statements. While present value calculations are used in financial reporting to determine the value of certain assets and liabilities, its primary purpose is to assess the value of future cash flows in today’s terms and aid in decision-making regarding borrowing and investment.
5) Yes
6) Yes
Can you please explain me the topics for which we can use Present value and FUTURE VALUE respectively.
1. As u said that Present value can be used for both borrowing and investment purposes but is it also correct that future value is used only for investment, not fir borrowing purpose because this method can’t be used for borrowing?
2. Is it also true that Present value is widely used for investment appraisal projects only whereas present value is used less commonly for borrowing cases like in Buy and Lease questions. Is that correct to say? (Please define?)
3. How many topics do we come across in paper FM where we can split the present value to be between borrowing and investment cases separately?
4. What causes the interest rate to fall each year. For eg 10% interest rate is 0.10 but if we look at the discount factor table then after on year the interest rate has fallen to 0.909 (9.09%) then 0.826 (8.26%) and so on but what factors actually caused it to decrease every year?
5. What is the concept of “cost for money” where interest becomes necessary to be employed?
Thanks for your time ?
Present value can be used for both borrowing and investment purposes. However, future value is primarily used for investment purposes and is not commonly used for borrowing. The future value represents the value of an investment at a future point in time, taking into account the compounding of interest.
True, Present value is widely used for investment appraisal projects, as it helps in determining the profitability and feasibility of investment opportunities. It is commonly used to calculate the net present value (NPV) of cash flows associated with an investment project. On the other hand, present value is used less commonly for borrowing cases, such as in Buy and Lease questions. In these cases, the present value is used to compare the costs of different financing options, such as borrowing money to purchase an asset or leasing the asset.
In FM, there are several topics where the concept of present value can be split between borrowing and investment cases separately. Some of these topics include investment appraisal, cost of capital, lease vs. buy decisions, and capital budgeting. In these topics, the present value is used to evaluate the financial viability of investment projects, determine the cost of borrowing, and compare different financing options.
The interest rate falls each year due to several factors. One of the main factors is the time value of money, which states that the value of money decreases over time due to inflation and the opportunity cost of investing. As time passes, the purchasing power of money decreases, leading to a decrease in the interest rate. Additionally, changes in market conditions, monetary policy, and economic factors can also influence the interest rate.
The concept of “cost for money” refers to the cost associated with borrowing or using money. When interest becomes necessary to be employed, it means that borrowing money or using funds from external sources comes with a cost in the form of interest payments.
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