Question

an investment product promises to pay $60,000 at the end of 10 years. if an investor feels this investment should produce a rate of return of 12%, compounded annually, what's the most the investor should be willing to pay for the investment?

Answer 1

The most the investor should be willing to pay for the investment (Present Value) is $19,318

Future value                 = 60,000

Period                        n = 10 years

Rate of return            r = 12% or 0.12

Now to find amount of investment we will use present value formula

Present value = $\frac{Future Value}{(1+r)^n}$

Present value = $\frac{60000}{(1+0.12)^1^0}$

Present value = $\frac{60000}{3.1058}$

Present value = 19,318.39

Round off the nearest dollar

Present value = $19,318

• According to present value, money that is spent today is worth more than money that is spent tomorrow.
• In other words, present value demonstrates that a sum of money obtained in the future is not as valuable as a similar sum received today.
• The predicted yearly rate of inflation or the rate of return on investments could cause money that is not spent today to lose value in the future.
• Assuming that a rate of return might be achieved on the funds over the time is necessary to calculate present value.
• The predicted cash flows of an investment are used to compute present value by discounting them to the present.

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