Present Value of Tomorrow’s Lump Sum

It is useful to be able to calculate the present value of tomorrows’ lump sum because it is used in the process of discounting future cash into present value.

As an example, let’s assume you the investor has been offered the opportunity that is projected to provide a $2,552.56 cash in flow at the end of five years. Let’s also predict that you could also earn a five percent (5%), compounded annually on a similar investment in Financial Partners’ Credit Union.  This 5% is in fact not opportunity cost, because the risks are not equal. The Credit Union has to pay the 5% increase at the end of the five years the investment opportunity may not. Therefore, in order to set this problem up properly let’s say you have a third opportunity which offers the same $2,552.56 at the end of five years for an investment with similar risk. That return on your investment is an opportunity cost compared against the first opportunity.

How much should you be willing to pay today for the future lump sum of $2,552.56 and receive at least a five percent return on your investment. Again, I use the Texas Instrument BA II Plus calculator.

On the fourth row and the top left corner are the keys we’ll be using.

CPT is used to calculate the problem.

N is for the number of time period.

I/Y is the interest yield

PV is present value

PMT is the payment on loan or investment

FV is future value

Thus, we have the following data.

N=5; I=5; PV=? PMT=0; FV=$2552.26

We enter the number value and then the key into our calculators;

5 N; 5 I/Y; 0 PMT; $2552.26 FV then we enter CPT and tell it what to calculate for us. CPT then we press the PV and the calculator show it would be worth $1,999.76 dollars today. Notice it give this number as a negative $1.999.76. This is because it takes money from your pocket today in order to receive the $2,5552.56 in five years.

Are these two investments equal, yes, they are interchangeable because based on what we know they have the same risk and produce the same outcome; however, they are not interchangeable with the Credit Union’s offer. The Credit Union’s offer is Fixed, you would receive 5% no matter what the economy does. You may think I’ll invest in the Credit Union.

You must consider what inflation is because these two forces work against each other. If the inflation is 12.5 like it was in the 80s then you would only lose 7.5 % on your investing The funds in the credit union. However, If you invested in a property As inflation rises so does the property’s value and your possible loss and gain was not fixed so you would be ahead of the game. If, however inflation fell below 5% you would lose on the property investment. The amount you can profit on your investments has peaks and valleys. Which ever one you choose plan to be in it as a long-term investment to reduce your risk.

Younger people have a tendency to assume more risk because they feel, they can replace their loss if need be. Older people like less risk because they have less time to recover their losses and they need it to maintain their lifestyle.

Note: Images on this blog site are from a free source or taken by the author. No image or group of photos is intended to represent the people the author serves. The author does not care about Race (that is a politically correct term that he does not like because we are all of the same Race, the Human Race. He prefers the term ethnicity, color, religion, sex, gender, marital status, disability, genetic information, national origin, source of income, Veteran or military status, ancestry, citizenship, primary language or immigration status.) He is a service provider for all people. We will all rise together when we band together and help one another. Joseph Erwin is a Real Estate Broker, DRE # O2131799, and a CA general contractor # B 696662. He’s a member of the CRMLS and The East Valley Association of Realtors located in the Inland Empire region of Southern California.