Mr X has been given an opportunity to receive Rs 1,060 one year from now. He knows that he can earn 6 per cent interest on his investments. The question is: what amount will he be prepared to invest for this opportunity?
To answer this question: we must determine how many rupees must be invested at. 6 per cent today to have Rs 1,060 one year afterwards.
Let us assume that P is this unknown amount, and using Eq. 2.1 we have: P(1 + 0.06) = Rs 1,060
Solving the equation for P, P = Rs 1,060/1.06 = Rs 1,000.
Thus, Rs 1,000 would be the required investment to have Rs 1.060 after the expiry of one year. In other words, the present value of Rs 1.060 received one year from now, given the rate of interest of 6 per cent. is Rs 1.000. Mr X should be indifferent to whether he receives Rs 1.000 today or Rs 1,060 one year from today. be can either receive more than Rs 1,060 by paying Rs 1,000 or Rs 1.060 by paying less than Rs 1.000, he would do so.