Which cash flow would you rather pay, $425 today or $500 in two years if interest rates are 10 percent? Why?

Question

Business

Abby Wood

17 March, 17:20

Which cash flow would you rather pay, $425 today or $500 in two years if interest rates are 10 percent? Why?

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Answers (1)

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Tate Huff · Answer 1

The main goal is to compare these two based on the same terms; present values. Find the present value of $500 today by discounting it using 10% interest rate over two years.

PV = FV / (1+r) ^n

where FV = Future value = $500

r = discount rate = 10% or 0.10 as a decimal

n = total duration of investment = 2

PV = $500 / (1+0.10) ^2

PV = $500/1.21

PV = $413.22

Since you are basing the decision on what you would rather pay, you would want a lower pay amount. The $425 is already in its present value terms and it is more expensive. Therefore, you would prefer to pay $500 in two years.