1 / 13

KRUGMAN'S MACROECONOMICS for AP*

24. Module The Time Value of Money. KRUGMAN'S MACROECONOMICS for AP*. Margaret Ray and David Anderson. What you will learn in this Module :. Why a dollar today is worth more than a dollar a year from now

kgillespie
Télécharger la présentation

KRUGMAN'S MACROECONOMICS for AP*

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. 24 Module The Time Value of Money • KRUGMAN'S • MACROECONOMICS for AP* Margaret Ray and David Anderson

  2. What you will learnin thisModule: • Why a dollar today is worth more than a dollar a year from now • How the concept of present value can help you make decisions when costs or benefits come in the future

  3. Veruca Salt appreciates the value of having things in the present. She wanted the “golden-egg-laying-goose” NOW!

  4. Borrowing, Lending, and Interest • Suppose you could have $1,000 today or $1,000 next year, which would you prefer? • Why? • You need money today. • You could put it in the bank and in a year you would have more than $1,000 • $1,000 today is worth more than a $1,000 tomorrow

  5. Borrowing, Lending, and Interest • When you lend money you earn interest. • Why do you need to earn interest? • The interest payment covers the cost to you of not having the money today • You could have saved it and earned interest. • You could have spent it and received an immediate benefit from it today.

  6. Borrowing, Lending and Interest Example: You are going to lend your friend $100, and he is going to pay you back in one year. Assume no inflation, you agree to a 10% interest rate, the going rate you could receive if you had simply saved the money. Why do you need to receive interest on this loan? The opportunity cost of lending your friend $100 is the interest you could have earned, $10, after a year had passed. So the interest rate measures the cost to you of forgoing the use of that $100. Rather than saving it, you could have spent $100 on clothing right now that would have provided immediate benefit to you. Repayment received on lending $100 for one year = $100 + $100*.10 = $100*(1+.10) = $110

  7. Defining Present Value • When evaluating a course of action, time must be taken into account because: • $1 paid to you today is worth more than $1 paid to you tomorrow • $1 that you must pay today is more burdensome than $1 that you must pay tomorrow • There is a difference between dollars received today and dollars received in the future. • Interest rates can be used to convert future benefits and costs into present value

  8. Defining Present Value • Let FV = future value of $ PV = present value of $ r = real interest rate n = # of years • The Simple Interest Formula FV = PV + (PV x r) $110 = 100 + (100 x .10) or FV = PV x ( 1 + r )n $110 = 100 x ( 1 + .10 )1 What this tells us is that a dollar today will generate a future value that is larger.

  9. Defining Present Value • We can also use this formula to calculate what a future payment would be worth today The Simple Interest Formula PV = FV / (1 + r)n PV =$110/(1.10) = $100 • This tells us that $110 received a year from now is worth $100 in today’s dollars.

  10. Defining Present Value • Money today is more valuable than the same amount of money in the future. • The present value of $X received one year from now is $X/(1+r). • The future value of $X invested today is $X*(1+r). • Interest paid on savings and interest charged on borrowing is designed to equate the value of dollars today with the value of future dollars.

  11. Using Present Value • Decisions often involve dollars spent, or received, at different points in time. We can use the concept of FV to evaluate whether we should commit to a project (or choose between projects) today when benefits may not be enjoyed for several years. Example: • What if you could invest $10,000 now and receive a guaranteed (after inflation) $20,000 later? Good deal? Maybe.

  12. Using Present Value • What if you had to wait 10 years to receive your $20,000? • If I put my $10,000 in an alternative investment earning 8%: FV is $21,589.25 = 10,000 x (1.08)10 • What is $20,000 in 10 years worth today? PV is $9,263.87 = 20,000 / (1.08)10

  13. Using Present Value If your grandma said you could have $5,000 when you graduate from college in four years, what is that money worth today? PV= FV / (1 + r)n PV = 5,000 / (1 + r)4 It depends on the interest rate If r = 3%, PV = $4,442.43 If r = 5%, PV = If r = 10%, PV =

More Related