Time Value of Money

[dawg87]

You are considering two lottery payment streams. Choice A pays $1,000 today and choice B pays $1,750 at the end of five years from now. Using a discount rate of 5%, based on present values, which would you choose? Using the same discount rate of 5%, based on future values, which would you choose? What do your results suggest as a general rule for approaching such problems? (Make your choices based purely on the time value of money.)

I know this much:


PV of A = $1000
PV of B = $1750/(1.05)5 = $1371.17

FV of A = 1000 x (1.05)5 = $1276.28
FV of B = ??????????????????

I just cant seem to figure FV of B out the answer is suppose to be 1500

 

[tkhunny]

It's not clear to me what is meant by "Discount Rate". Is this really a discount rate or are we just talking about general discounting?

1750/(1+0.05)^5 = 1371.17 -- But 5% is an interest rate, not a discount rate.
1750*(1-0.05)^5 = 1354.12 -- Now that's a discount rate.

As far as your question marks -- aren't you trying to find the future value of 1750 ALREADY AT 5 years?

Now, if you are talking about 2 years into the future, that's a different story.

1000 / 0.95^2 = 1108.03
1750 * 0.95^3 = 1500.41

It would be nice to see the entire original problem statement. There's a bit missing from the middle, I think.