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EXAMPLE 2.5

Mr X wants to find the present value of Rs 2,000 to be received 5 years from now, assuming 10 per cent rate of interest. We have to look in the 10 per cent column of the fifth year in Table A·3. The relevant PVIF as per Table A-3 is 0.621.

Therefore, present value = Rs 2,000 (0.621) = Rs 1,242

Some points may be noted with respect to present Values. First, the expression (or the present value factor for a years at 1 per cent. 1/ (1 + i)" is the reciprocal or inverse of the compound interest factor for n years at per cent. This observation can also be confirmed by finding out the reciprocal of the relevant present value factor of Example 2.5. The reciprocal of 0.621 is 1.610. The compound interest factor from A-1 (or 5 )Rs 5 at 10 per cent is 1.611. The difference is due to rounding off of values in Table A-1.

In other words, in Example 2.5, the sum of Rs 1,2-42 will be compounded to Rs 2,000 in five years at 10 per cent rate of interest |Rs 1,242 x 1.61n= Rs. 2,000.862|. The difference of Re 0.862 is attributable 10 the fact that the table values are rounded figures. This indicates that both the methods, compounding and discounting of adjusting time value of money, yield results, Second, Table A-3 shows that the farther in the future a sum is 10 be received, the lower is its present value. See, for instance, the following extract from Table A-3:

Thus, the higher the discount rate, the lower is the present value factor; and the longer the period of time, and correspondingly, the lower is the present value factor. A1 the discount rate of zero per cent, the present value factor always equals one and, future value of the funds equals their present value. But this aspect is only of academic importance as in actual practice the business firms can rarely, if ever, obtain the resources (capital) at zero rate of interest.