Page 262 - BA2 Integrated Workbook STUDENT 2018

Chapter 14

3.2 Discounting

Discounting performs the opposite function to compounding. Compounding finds the
future value of a sum invested now, whereas discounting considers a sum receivable
in the future and establishes its equivalent value today. This value in today’s terms is
known as the Present value.

Present value Future value

Formula for discounting:

Future value (V)
Present value (X) = ————————
n
(1 + r)

This can be shown as:

1
Present value (X) = Future value (V) × ———
n
(1 + r)
or
–n
Present value (X) = Future value (V) × (1 + r)

1
–n
Where or (1 + r) is known as the discount factor
n
(1 + r)
How much would $5,000 receivable in 3 years’ time be worth today if the interest rate
is 8%?

X = 5,000 × (1 +0.08)-3 = $3,969.16

Illustrations and further practice

Now try TYU 6 and 7

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