Present Value Example 2ab


Present Value  EXAMPLE 2a 
Tom and Marg Kiernan are currently looking for a home that will produce a healthy return on their investment down the road. They have recently seen a nice bungalow selling for $100,000 in town. Their real estate agent has told them that it will probably double in value in about 15 years. Marg really likes the home. However, Tom wants to make sure that the home is really worth $100,000 today. Based on the fact that it may double in value in 15 years. Calculate the Present Value of the house. 
What is the house worth in today’s dollars? What is the Present Value of the
house?
Since no discount rate is given, this is the first thing that must be determined.
For this example we will use the current inflation rate.
Fact: Assume the Inflation rate is 5% per year.
Fill out your form the same as the one illustrated below.
Press

button beside the Initial Investment field.
The Present Value amount Today of $200,000 15 years from now discounted at an interest rate of 5.00% is $96,203.42 
In other words, if inflation averages 5% a year and their property only doubles in value over the
15 year period, they will have actually lost $3,796.58 in purchasing power.
So you see that the $200,000 home the couple wants to buy because it will double in value in
15 years is only worth $96,203.42, in today’s dollars!! Therefore, if the agent is right, and if
Tom really wants to buy the home, he should only pay $96,203.42 or less for it.
Again let’s look at another Present Value question, this time one involving an investment decision.
The Beginning Amount or the Present Value.
Present Value  EXAMPLE 2b 
Suppose you have a piece of land that you paid $60,000 for. You have estimated that you can build a professional building on it for $350,000 dollars. You will be able to sell the property for $525,000 in two years. However, the local developer wants to buy your property and is willing to pay you $425,000. Is $525,000 in two years worth more then $425,000 today? Assume that the market interest rate is 12%, and the inflation rate is still at 5%. 
Fill in all of the information provided in the example into your Future Value
Form and compute the unknown variable. In this case the unknown variable is the
Beginning Amount field.
Check your form and solution with the illustrated example below.
Fact: The reason the Interest rate is 7% and not 12% has to do with inflation. Since the inflation rate is 5%, it has to be subtracted from
the 12% to obtain the real interest rate.
Press

button beside the Initial Investment field.
The Present Value amount Today of $200,000 15 years from now discounted at an interest rate of 5.00% is $458,555.33 
This is what the property is worth today according to your evaluation of it. The developer is not doing you any favor by offering you only $425,000.