![]() This is the REAL interest rate (Gross adjusted for inflation, gives you the real buying power of the currency). If you were going to make 5% a year on the deal, you will now be making 3%. All you have to do is adjust your discount rate (the gross interest rate). Let's assume that in Country A, inflation is always rising by a steady 2%. While it is not directly involved, it can easily be understood and inferred. Now what I think you're really trying to get at is inflation and the physical value of money. That sort of emotional/societal value is not included. In some cases in life, it is more worth while to have $150 dollars today than $20,000 in 10 years. ![]() ![]() If by value of money, you mean value of liquid assets, no. The exercise does NOT include those figures, sort of. Inflation basically is the value of money, domestically at least. Clearly more than the $110.25 in option 1. Using the FV interest calculation given in a previous video we have (1.05)^2 multiplied by $101.25 (the present value of the investment) which gives us $111.63. And the same goes for $35 in two years at 2%.Īnother way to think about it is that the present value as Sal calculated is $101.25. That is exactly the formula Sal gave ($50/1.01). The correct logic is to ask the question: How much money would I need today to have $50 in a year at a 1% interest rate. This conundrum is the entire reason for using the discounting method. Similarly, $35 is what the value WILL BE in 2 years time. Therefore you can't use addition to simply sum $20, $50*1.01, and $35*(1.02^2) because $50 isn't the present value it's the FUTURE VALUE in one year's time. You won't have access to the $50 for a whole year and the $35 for a whole two years. I will invest $35 at a 0% interest rate STARTING NOWĭo you see the error? You are assuming a timeline that starts all of your investments at the current time. I will invest $50 at a 1% interest rate STARTING NOW I will invest $20 at a 5% interest rate STARTING NOW Think about what you are really saying in your example: HankyUSA, this is a great question, but your (and the rest of the responders') logic is slightly off.
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