Finding a present value is the reverse of finding a future value. Which of the f

Question

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 so that it grows toa given future amount at a specified rate of return. Which of the following investments that pay will $9,500 in 10 years will have a lower price today? The security that earns an interest rate of 17.25%. The security that earns an interest rate of 11.50% O . Eric wants to invest in government securities that promise to pay $1,000 at maturity. The opportunity cost (interest rate) of holding the security is 5.40%. 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 four years An investment that matures in three 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 O Other things remaining equal, the present value of a future cash flow increases if the investment time period increases

Explanation / Answer

Present value (PV) from a future amount (FV) at a give rate of interest (r) for a specified number of time periods (n) is computed as follows -

PV = FV / (1 + r)n

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) We divide the future value with the given rate of interest. Therefore, the higher the rate of interest or denominator, the lower will be the present value.

The security that earns an interest rate of 17.25%.

3) The longer the maturity period, the lower will be the present value as longer maturity period also increases the denominator.

An investment that matures in four years.

4) Other things remaining equal, the present value of a future vash flow decreases if the investment time period increases.

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