Mohsin Nadeem 18L-0101 BBA-B

National University of Computer and Emerging Sciences, Lahore Campus

Course: Macroeconomics
Program: SPRING
BBA Semester: 2020
Total
Type: Assignment 4 Marks: 40
Submission
Date: 27-03-2020. Weight -
Section: BBA (B) Page(s): 1
18L-
Name: Mohsin Nadeem Roll No: 0101
Instruction : Please submit your assignment on due date via email and Google
classroom too. Please write your name, roll number, class-section in
this very order, otherwise your assignment won't be considered.

Email ID: fatima.saif@nu.edu.pk

QUESTION:

Describe each concept with definition, explanation /components and application/mathematical

example.
1) Difference between Future value and present values.
2) How these concepts are effected by inflation?

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Table of Contents

Introduction:................................................................................................................................................3
Difference between the Present and Future values......................................................................................3
Similarities..................................................................................................................................................4
Example.......................................................................................................................................................5
Present Value...........................................................................................................................................5
Future Value............................................................................................................................................5
Net Present Value........................................................................................................................................5
Example of NPV.....................................................................................................................................5
IRR (Internal Rate of Return)......................................................................................................................5
Example of IRR.......................................................................................................................................6
How these concepts are effected by inflation?.............................................................................................6
Effect of IRR on Inflation........................................................................................................................6
Reference.....................................................................................................................................................7

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Introduction:

Business owners and other investors use the concept of monetary policy approximately every
day. Generally, both of the Present and Future Value concept is derived from the time value of
money and its monetary concept. In other words, we can say that it can be a simple idea that
whatever money we received today is having the worth more than the money to be received one
year from now or any other date in the future.

The concept of present value is most fundamental and pervasive. Present value provides us with
an estimated amount to be spend by us today and then, to have an investment worth of a certain
amount in the future and moving towards the future value, it tells us that how much money you
will get in any sort of investment in the future. Basically, Present and Future Values are the
terms which are used in the financial world to calculate the future and the current worth of
money.[ CITATION edu19 \l 1033 ]

Difference between the Present and Future values

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Involve both discounted as well as interest rate. Involved only interest rate.

It is the current value of future cash flow. It is the amount of money which will grow
over period of time with simple or compound
interest.

Investors take the decision whether to reject or Only future gain of total investment is shown
accept the proposal with the help of present by future value. Hence, decision making for
value method. the investment is less here.

It can be founded using, It can be founded using,

PV=CF/(1+r)n FV=PV or CF/(1+r)n

The Present Value PV has the concept of “what The Future Value FV has the concept of “If
amount we invest today to get the specific we invest some money today, what will be the
amount in future?” amount we get at the future date?”

In present value, future value is given. In case of future value, present value is given.

The process of finding present value is called as The process of finding future value is called as
discounted and whereas, capitalization.

Similarities
There exist some similarities between present value and future value. They are as follows.
1. Both are useful for appraising investment tools and interdependent, i.e. one determines by
the other.
2. If the interest rate and the period remain constant, the present value and future value vary
in a synchronized manner, i.e. if the future value increases, the present value also
increases and vice versa.

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Example
Present Value
Let’s take an example, you have been promised by your friend that he will give you Rs 5000 till
5 years from today and interest rate is 10% so no we want to know what the present value of Rs
5000 which you will receive in future so,

PV = 5,000/ (1+0.1)5
PV = 909.1
So present-day value of Rs 5000 is Rs 909.1
Future Value
Suppose Hasan is investing a sum of Rs 3000 in some fixed deposit for one year and Hasan will
receive interest with a rate of 7%. So at the end of year Ram will receive 3210 Rs that is 3000
Principal plus Rs 210, which is the interest. So we can say that Rs 3210 is the future value of
today’s money that is of Rs 3000.

Net Present Value

Present value of a money in contrast to its future value when invested at compound interest.
Compound interest is the rate of interest not only charged on the principal amount but also on the
interest amount of each year. It is the present value of all cash flows. Cash inflows (money
coming to you) being positive and cash outflows (money that you give up e.g. investment) being
negative which concludes that NPV can be considered as a formula for revenue minus cost.

Example of NPV
100rs with an interest rate 10% compounded annually will have Fv of 1 year 110rs, 2 year 121 (as 10% of
100 and 10% on the interest rate of each year which is 10). So the NPV of 121rs of future (2 years) is
equal to Rs 100 of today.

IRR (Internal Rate of Return)

IRR is a measure of investments rate of return or used in capital budgeting to estimate the
profitability of potential investments.
IRR is the rate of growth a project is expected to generate. IRR is calculated by the condition that
the discount rate is set such that the NPV = 0 for a project. IRR is used in capital budgeting to
decide which projects or investments to undertake and which to forgo.

Example of IRR

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Year Cash inflow (in Rs) Cash outflow (in Rs)

0 - 100000
1 25000 -
2 25000 -
3 25000 -
4 25000 -
5 25000 -

Firstly, we will calculate NPV with the formula: Present value of all returns – Present value of all
investments. The answer from above information NPV is -5231. Then we calculate IRR and
obtain its value of 7.38%.

How these concepts are effected by inflation?

Inflation is the phenomenon that results in decreasing in purchasing power of money and
increase nominal value of revenue and expenses. If you receive money today, you can buy goods
at today’s prices. Inflation will cause the price of goods to rise in future, which would lower the
purchasing power of your money. A rise in demand can push prices higher, while a supply
reduction can also drive prices. Money not spent today could be expected to lose value in the
future by some implied annual rate, which could be inflation or the rate of return if the money
was invested. The present value formula discounts the future value to today's dollars by factoring
in the implied annual rate from either inflation or the rate of return that could be achieved if a
sum was invested. Inflation has the power to erode a person's annual rate of return. When the
annual inflation rate exceeds the rate of return, the consumer loses money when they invest it
because of the decline in purchasing power. For instance, when hyperinflation ravaged countries
people with money in low interest-bearing savings accounts lost significant amounts of money.
In cases of high inflation, people should spend money in the present to avoid having the money
be worth less in the future. On the other hand, people have an incentive to invest money when
their investment yields a greater return than the rate of inflation.
Effect of IRR on Inflation
For instance, when hyperinflation ravaged countries people with money in low interest-bearing
savings accounts lost significant amounts of money. In cases of high inflation, people should
spend money in the present to avoid having the money be worth less in the future. On the other
hand, people have an incentive to invest money when their investment yields a greater return
than the rate of inflation. Inflation has the power to erode a person's annual rate of return. When
the annual inflation rate exceeds the rate of return, the consumer loses money when they invest it
because of the decline in purchasing power.

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Reference

(2019, 03 17). Retrieved from educba: https://www.educba.com/present-value-vs-future-value/

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