Click for the transcript of "Finance Basics 6" video.

PRESENTER: Here, I'm going to go through three examples of a typical present value problem or question in a finance class of college level, or something similar to that. Now in a previous tutorial, I've already told you what the present value function is, how to use it, and basically what present value means. So this one, I'm not going to spend too much time on that. So let's go ahead and dive right on in.

The first question is a very basic one. With an interest rate of 6%, what is the current value of $7 million if you will receive it in 15 years? This is sort of a typical example. What's worth more? So much in the future, or so much now? So let's figure out what it's actually worth in today's dollars, or using only interest rate.

So equals, pv, open parentheses. Now our rate, that's very easy. Just our interest rate of 6%. So 0.06. Now remember, when you're doing the interest rate here, you have to do it as a decimal. So 0.06. You can't type in a whole number like 6. It's not going to interpret that correctly.

The number of periods. Well, that's very easy. It's 15 years. So our number of periods-- 15 comma. Payment-- are we going to be paying into this at all, or is anyone going to be paying us at all over these 15 years? No. So payment is 0, because we're only talking about one lump sum in 15 years.

But we do know the future value. So what is the future value? $7 million. Now if you wanted, you could type it in as seven, 7, 7,000, or actually, 7 million. If you're doing this in the real world, you're going to break it down to a smaller number, such as 7, for 7 million.

So now we have the rate, right here. The number of periods-- 15. Payment is 0, because we're not going to be paying into it. It's not an annuity. And the future value is 7 million. Let's close parentheses, and hit Enter.

So it tells us that the present value is just about $3 million. Now why is this red? Why is this negative? Well, because it's assuming that this is your cash outflow. So you're going to put this 3 million in, say, a bank or a bond that pays 6%. And to put your money into something, you have to pay it out.

But to get rid of the red, the negative, simply put a little minus sign right in front of the pv function. Once you do that, you'll notice that it's a positive number once again.

All right, so let's go ahead and go to the second present value problem, on the second tab. What is the present value of putting $500 into an interest bearing account with a 2.75% interest rate for 6 years?

Now this would be considered the basic annuity problem, right? An annuity, a set of equal cash flows that you're investing at an equal rate over a period of time. So the equal cash flows being $500 invested, let's say, once a year for 6 years. So we're going to keep it easy by keeping it at years for now.

So equals, pv, open parentheses. Our rate, very easy-- 2.75%. Remember, put it in decimal form, 0.0275 comma. Number of periods, very easy. We're sticking with years for now, so 6 comma. Now the payment. Well, this time, we are going to be paying into the account every year. So the payment here is going to be 500, because that's how much we're paying in.

Now we don't have to worry about a future value for this problem, because we're not trying to figure out how much one lump sum in the future is worth today. We have many payments into the account. So close the parentheses. We got the percentage for our rate, number of periods, 6, and the payment, which is $500 going in every period.

Simply hit Enter, and we see you will end up with, or in today's dollars, it's $2,731.18. Once again, to make that positive, double-click, put a negative sign in front of it, and hit Enter. And that's it for that problem.

So just remember that since this is an annuity, we do have to fill in the argument for the payment. This one right here-- pmt. So the payment basically is what you're going to do for an annuity, right? Future value, if you want to figure out what one lump sum is worth today.

So let's go on to the third example. It's a little bit different, maybe a little bit trickier, but same premise. So if you know that you can sell something, say, an asset, in 3 years for $170,000, right? And you know that the discount rate for the asset is 4.25% per all of your due diligence and your own research. Well, then, what are you going to pay for the asset now?

So this is a present value. It's a little bit different, but the point is, how much money you going to shell out now so that you can sell it for 170 grand in the future with a 4.25% discount rate? All right, so the way to do this, exactly like before, just a different word problem.

So equals, pv, open parentheses. Once again, our rate. Well, that's easy, right? Discount rate, that's our rate-- 4.25%, so 0.0425. Now how many years would we like to discount this for? Well, we want to discount it for 3 years, so 3 for the number of periods. Number of periods-- 3.

Now for the payment, are we going to have any payments in or out? Well, let's say that this is a non-cash flow generating asset, right? Could be a mainframe for data backup, or something like that. So the payment's going to be 0.

But we do have a future value. The future value is $170,000. If you had it in thousands, you would simply write 170, but I'm going to put the full number here-- 170,000. Close the parentheses and we're done.

So all I did here, the rate is the discount rate this time. It's not called interest rate, but it's the same thing for our purposes, for what we're doing. Number of periods-- 3 years. And there is no payment. It's just a simple lump sum in 3 years, right? It's worth $170,000 in 3 years. So that is the future value of it.

Now what's it worth today? Let's hit Enter and find out. So today, it is worth $150,044.72.

Now once again, this is a negative number. You can see red has the parentheses around it, because you have to pay that much money in order to get this asset, or to gain the asset. So it's considered a cash outflow, right? Negative. But to make it a positive number, simply go before the function, negative sign, Enter, now we have a positive number.

So that's about it for these three examples. I think we've pretty much covered a broad range of things. This was probably the most difficult example. But don't forget, just because the word problems, the wording's a little bit different, the inputs are going to be relatively the same. So that's it for these examples.