Present Value 3 | Interest and debt | Finance & Capital Markets | Khan Academy | Summary and Q&A

TL;DR

The video explains how changing the discount rate affects the present value of future payments, showing that lowering the rate increases the present value.

Key Insights

• 🈹 Present value is determined by discounting future cash flows based on a chosen discount rate.
• ☠️ Decreasing the discount rate increases the present value of future payments.
• 😘 Payments further in the future have a lower present value compared to immediate payments.
• 🥺 Different discount rates can lead to different rankings of payment streams in terms of present value.

Transcript

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Questions & Answers

Q: How does changing the discount rate affect the present value of future payments?

Lowering the discount rate increases the present value of future payments, as seen in the example where the present value increased by $6 when the rate decreased from 5% to 2%.

Q: Why did choice number two benefit more from the decrease in the discount rate compared to choice number three?

Choice number two benefited more because all of its payment was two years out, which was the term affected the most by the decrease in the 1.02 squared discount factor. Choice number three had payments spread out over different time periods, resulting in a lesser improvement in its present value.

Q: What is the relationship between interest rates and the present value of future payments?

When interest rates decrease, the present value of future payments increases. This is because discounting by a smaller number (lower interest rate) results in higher present value.

Q: How does the present value of a payment change when the payment is further in the future?

The present value of a payment decreases as it becomes further in the future. This is because discounting factors become larger when applied multiple times, reducing the present value.

Summary & Key Takeaways

• The video discusses the concept of present value, using a 5% discount rate to determine the present value of different payment streams.

• It demonstrates how compounding forward and discounting backward are the same operation.

• The video then explores what happens when the discount rate is changed to 2%, showing how the present value of future payments increases.