imported>Doug Williamson |
imported>Doug Williamson |
| Line 1: |
Line 1: |
| (PV).
| | 1. |
|
| |
|
| Today’s fair value of a future cash flow, calculated by discounting it appropriately.
| | ''Pensions''. |
|
| |
|
| The appropriate rate to discount with is the appropriately risk-adjusted current market [[cost of capital]]. | | The linking of pension entitlements to a price index. |
|
| |
|
|
| |
|
| ==Calculation of present value==
| | 2. |
|
| |
|
| We can calculate present value for time lags of single or multiple periods.
| | The linking of any money amount to a price index. |
|
| |
|
|
| |
|
| <span style="color:#4B0082">'''Example 1: One period at 10%'''</span>
| |
|
| |
|
| If $110m is receivable one period from now, and the appropriate periodic cost of capital (r) for this level of risk is 10%,
| | Also known as "indexation". |
| | |
| the Present value is:
| |
| | |
| PV = $110m x 1.10<sup>-1</sup>
| |
| | |
| = '''$100m'''.
| |
| | |
| | |
| And more generally:
| |
| | |
| PV = Future value x Discount factor (DF)
| |
| | |
| Where:
| |
| | |
| DF = (1 + r)<sup>-n</sup>
| |
| | |
| :r = cost of capital per period; ''and''
| |
| :n = number of periods
| |
| | |
| | |
| <span style="color:#4B0082">'''Example 2: One period at 6%'''</span>
| |
| | |
| If $10m is receivable one year from now, and the cost of capital (r) is 6% per year,
| |
| | |
| the Present value is:
| |
| | |
| PV = $10m x 1.06<sup>-1</sup>
| |
| | |
| = '''$9.43m'''.
| |
| | |
| | |
| <span style="color:#4B0082">'''Example 3: Two periods at 6%'''</span>
| |
| | |
| Now let's change the timing from Example 2, while leaving everything else the same as before.
| |
| | |
| If exactly the same amount of $10m is receivable, but later, namely two years from now,
| |
| | |
| and the cost of capital (r) is still 6% per year,
| |
| | |
| the Present value falls to:
| |
| | |
| PV = $10m x 1.06<sup>-2</sup>
| |
| | |
| = '''$8.90m'''.
| |
| | |
| | |
| The longer the time lag before we receive our money, the less valuable the promise is today.
| |
| | |
| This is reflected in the lower Present value ($8.90m) for the two years maturity cash flow, compared with the higher Present value of $9.43m for the cash flow receivable after only one year's delay.
| |
| | |
| Even though the money amounts receivable are exactly the same, $10m, in each case.
| |
|
| |
|
|
| |
|
| == See also == | | == See also == |
| * [[Adjusted present value]] | | * [[Limited Price Indexation]] |
| * [[Annuity factor]] | | * [[Output price index]] |
| * [[Compounding factor]]
| | * [[Retail Prices Index]] |
| * [[Discount factor]]
| | * [[Consumer Prices Index]] |
| * [[Discounted cash flow]]
| |
| * [[Economic value]]
| |
| * [[Future value]]
| |
| * [[Internal rate of return]]
| |
| * [[Intrinsic value]]
| |
| * [[Net present value]]
| |
| * [[Profitability index]]
| |
| * [[Terminal value]] | |
| * [[Time value of money]] | |
| | |
| [[Category:Corporate_finance]]
| |
| [[Category:Long_term_funding]]
| |
| [[Category:Manage_risks]]
| |
| [[Category:Trade_finance]]
| |
