Week 2 Forum 2

Week 2 Forum 2
Name:
Institutional Affiliation:
Week 2 Forum 2
Option A: $10,000 (present Value)
Option B $20,000 (Future value)
Interest to be Earned 6.5%
Time period 10 years
P.V. formulae
PV=FV (1+i)–n or PV= FV/ (1+i) n
F.V. formulae
FV=PV (1+i) n
Calculations:
Option A: (Future value of $10,000)
FV= $10,000(1+0.65)10
= $18,771.3747
Option B (Present value of $20,000)
PV=$20,000(1.065) -10
=$10654.5207
If I base my decision on the present value I would choose option B because it gives more value for the money which is $10,654.5207 rather than option A which gives only $10,000.
On the other hand, if I base my decision on the future value I would choose option B also because it gives more value for money which is $20,000 rather than option A which gives $18,771.3747.
My answers are different because of the risk factors included in the interest rate; these risk factors affect the time value for money which postulates that a present dollar is more valuable than the same amount given in future (Campbell & Shiller, 1987). This is so because the dollar at hand today can be invested to earn capital gains/ interest as opposed to the same amount earned in future.
The risk of loss of value of money due to factors like inflation, a possible devaluation of currency by the government, loss of purchasing power, adverse political changes and changes in exchange rates is included in the interest rate hence bringing about the difference in the two answers obtained in my calculations above.

The compounding effect increases the future value of money as the accumulated interest earns more interest (generating earnings from previous earnings). Therefore, the uncertainties brought about by the above factors affect the value for money over time.
Reference
Campbell, J. Y., & Shiller, R. J. (1987). Cointegration and tests of present value models. Journal of political Economy, 95(5), 1062-1088.