Pension and Present value: Difference between pages

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A pension is a periodic payment made to a Pensioner under a pension scheme.
(PV).  


In some countries, such as Australia, the term can alternatively be applied to a lump sum payment on retirement.
Today’s fair value of a future cash flow, calculated by discounting the future cash flow at the appropriately risk adjusted current market [[cost of capital]].
 
 
==Calculation of present value==
 
We can calculate present value for one or more periods.
 
 
<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%,  
 
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 for the two years maturity cash flow of $8.90m, compared with $9.43m Present value for the cash flow receivable after only one year's delay.




== See also ==
== See also ==
* [[Annuity]]
* [[Adjusted present value]]
* [[Asset risk]]
* [[CertFMM]]
* [[Benefit]]
* [[Compounding factor]]
* [[Dependant]]
* [[Discount factor]]
* [[Employee Retirement Income Security Act]]
* [[Annuity factor]]
* [[Means testing]]
* [[Discounted cash flow]]
* [[Morris Review]]
* [[Future value]]
* [[Pension cost]]
* [[Internal rate of return]]
* [[Pension liabilities]]
* [[Intrinsic value]]
* [[Pension scheme]]
* [[Net present value]]
* [[Pensions risk]]
* [[Profitability index]]
* [[Replacement ratio]]
* [[Terminal value]]
* [[Trust]]
* [[Time value of money]]
* [[Trust deed]]


[[Category:Accounting,_tax_and_regulation]]
[[Category:Corporate_finance]]
[[Category:The_business_context]]
[[Category:Long_term_funding]]
[[Category:Manage_risks]]
[[Category:Trade_finance]]

Revision as of 14:30, 2 December 2015

(PV).

Today’s fair value of a future cash flow, calculated by discounting the future cash flow at the appropriately risk adjusted current market cost of capital.


Calculation of present value

We can calculate present value for one or more periods.


Example 1: One period at 10%

If $110m is receivable one period from now, and the appropriate periodic cost of capital (r) for this level of risk is 10%,

the Present value is:

PV = $110m x 1.10-1

= $100m.


And more generally:

PV = Future value x Discount factor(DF)

Where:

DF = ( 1 + r )-n

r = cost of capital per period; and
n = number of periods


Example 2: One period at 6%

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 1.06-1

= $9.43m.


Example 3: Two periods at 6%

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 1.06-2

= $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 for the two years maturity cash flow of $8.90m, compared with $9.43m Present value for the cash flow receivable after only one year's delay.


See also