Calculating Present Value

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Present value is mostly a concept that is used by financial advisors analyzing deals from leases to commodity purchases and mergers and acquisitions. Present value explains the relation of a single dollar today compared to one dollar tomorrow.

Example: Anrult Dermenage is selling a piece of real estate in Redwood City. Yesterday, he was offered USD 10, 000 for the property . Today, another buyer offered him $ 11, 424, however, the second offer is to be paid one year from today. Anrult has satisfied himself that both offerors are honest and fiscally solvent. He and his home broker believe that none of the offers will fall through or experience payment troubles . Which of the two offers should Anrult take ?

The answer depends on what Anrult will do with the cash he receives at this point. If he has an opportunity to invest the money safely in a bank account and get a 12 % interest, per year he will have $ 11, 200:

$ 10, 000 [return of principal] + (0. 12 * USD 10, 000 [interest he is going to get])= $ 11,200. Because this is less than the $ 11, 424 he will receive from his 2nd buyer, Anrult should accept the other offer.