24 May Corporate Finance
Present value has been an interesting term to learn about in the chapter. On the surface, present value would seem like an obvious term; the value something currently has. However, from a finance perspective, it can be more complex than that. Example 4.10 in the text helped me visualize this best. The example involves a lottery winner getting a $20k payout on year one, and a $50k payout on year two. By doing the present value calculation, we learn that it would be essentially the same to receive $63,367.70 now instead of $70k over two years. Without knowing present value, one would naturally assume $70K over two years is better than $63k right away.
It is important to understand how less money now can be the same as more money later, thanks to earning interest. It is necessary to do the calculation for present value to determine how much of a discount one can take one receiving a lower initial payment versus a greater payment amount over a longer time period. If calculated correctly, it will often be advantageous to take the entire, yet reduce sum right away and begin investing, versus waiting for it to be paid over time.
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