Another important topic (one that you’ll cover in greater detail in Finance subjects) is called discounting. We’ll keep this basic since the class example explained this pretty well.
Bascially, we’re assuming a dollar today is worth more than a dollar next year. This is true for a number of reasons, none of which are really central to this course. All you have to know is that, unless noted otherwise, the discount rate is equal to the interest rate (r). To get to the Present Value of the cash we will get in the future, use the simple formula
Present Value = Future Value / [(1+r)^n]
where n is the number of years and r is the discount rate. Future Value is the money (or equivalent) you'll have in the future, and the Present Value is how much that money is worth NOW.
That’s basically it; you need to know this for question 1 in this week’s homework. This concept is easy to understand but application intensive, and it will pop its head up throughout the course.
^_^
Friday, February 20, 2009
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DISCOUNTING. For simplicity in the calculations, Sven encouraged us to use the generic formula:
ReplyDelete(1 - (δ)power t) / (1 - δ)) x X
Where δ = 1 / (1+r)power t (discount factor)
I tried and it works, but if you do the calculations (not in excel) considering not too much decimals, the result is slightly different... My question is how many significant digits we should take into consideration for the calculation?