What is it worth?
Everybody wants money, both now and later, and we instinctively know that now is better than later. How much better? Well, that is a major point of this chapter. In this chapter, we learn how to compute how much an investment made today will be worth at some future date, the present value of a lump sum to be received in the future, and how to find the return on investment when we know the present value and the future value. We will build on this expertise in future chapters. In Chapter 5, we will learn about evaluating cash flows. In later chapters, we will learn about using the time value of money to make decisions about investments. In class, I will show you how to use some of these same techniques for personal decisions, such as buying a house or car or purchasing on credit.
Sports figures often negotiate for financial deals spread over 10 years. They may think they are getting one figure, but the present value of the package may be far less than they think. In accident suits, victims are often offered their choice of several packages. Being able to put everything in terms of the present value allows both athletes and victims to see the current value of the offer and compare the offers properly. Lottery winners are often disappointed when they realize what they will actually get.
In a business, we need to look at investments in machinery, computer systems, and marketing campaigns in terms of expected return over a period of years, and see if the expenditure of cash now is warranted by the payback of the purchase.