Present & Future Values of Multiple Cash Flows

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  • 0:03 The Time Value of…
  • 1:15 Present and Future…
  • 2:22 Calculating Present Value
  • 2:58 Present Value -…
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Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

$100 today is not worth the same as $100 was 50 years ago, nor is it worth the same as $100 will be in 50 more years. In this lesson, we'll discuss the time value of money and how it influences the present and future values of cash.

The Time Value of Money (a.k.a. Inflation)

The value of cash changes over time; that is simply an economic fact. Did you ever hear a grandparent talk about 'the good ole days' when candy cost a penny and a soda cost a nickel? Now, that same candy and soda - instead of costing a total of six cents - would cost you around $2. Why is that? Has soda and candy become scarcer, and therefore, more valuable? No. But, the cash you use to pay for that soda and candy has lost some of its value. This idea is known as the time value of money.

The time value of money is an important concept, that refers to the economic fact that money generally loses its value over time and the idea that money can potentially be invested in other ways for a more valuable return in the same period. The lost opportunity to invest money differently is called opportunity cost. Inflation, on the other hand, is actually a measurement. Inflation is the rate at which money loses its value due to increases in the costs of goods and services. So the amount of groceries you could buy a year ago with 50 dollars was likely more than what you can buy today with 50 dollars.

Present and Future Value of Cash Flow

The time value of money is an important concept to understand, especially when it comes to investing today's cash into something that will earn cash in the future. Since the money in the future isn't worth as much as the money being invested today, it is necessary to adjust the future amounts for the time value of money. Basically, it is essential to calculate how much money an investment will return, expressed in today's dollars, so that the cost of the investment can be compared to the expected return in an apples-to-apples way.

The future value of a lump-sum of money is calculated using the formula FV = PV(1+i)^n. In this formula, FV is the future value, PV is the lump sum, i is the rate at which it grows, and n is the number of periods into the future. An important issue with this formula is to make sure that the i and n are consistent. If you are measuring n in years, for example, make sure that i is a yearly rate. If you are measuring n in quarters, make sure that i is a quarterly rate.

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