Calculate the present value of a series of future cash flows. More specifically, you can calculate the present value of uneven cash flows (or even cash flows).
Suppose you were offered an investment that would pay you a cash flow stream over the next 7 years of 100, 200, 300, 400, 500, 600, 700. The total of these cash flows is 2,800 but if your required return on any investment is 11%, what is the maximum you should be willing to pay for this investment?
The present value, PV, of a series of cash flows is the sum of the present value of each cash flow, CF, where i is the interest rate in decimal form and n is the period. The equation for the present value of each cash flow in the series is:
PVn = CFn / (1 + i)n
For example, i = 11% = 0.11 and for period n = 5, CF = 500.
PV5 = CF5 / (1 + 0.11)5
PV5 = 500 / (1 + 0.11)5
PV5 = 500 / (1.11)5
PV5 = 500 / 1.685058
PV5 = 296.73
Calculating the PV for each cash flow in each period you can produce the following table and sum up the individual cash flows to get your final answer. If you wish to get a minimum return of 11% annual return on your investment your should pay, at most, $1,689.94 lump sum for this investment at the beginning of period 1 (time 0).
|Period||Cash Flow||Present Value|