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Money has no legs of its own and yet it keeps on moving around faster than all of us. This makes money all powerful. But time is a great leveller. What looks like a mountain of money today may become dust tomorrow if money does not keep on moving with time.
Johnny is, however, interested in understanding things in the reverse order. A fortune-teller has predicted that Johnny will have a mountain of money after 30 years. Johnny wants to know the present worth of his future mountain of money. In other words, Johnny wants to know how he can calculate the present value of future money.
Jinny: Hi, Johnny! Why are you standing on your head today?
Johnny: I am trying to understand things in the reverse order. If I have a mountain of money after 30 years, what is its actual worth today?
Jinny: Well, you just need to make smart use of your calculator to know that. If somebody promises to pay you Rs1 crore after 30 years, you may feel that after 30 years you would have a mountain of money. But don’t entertain the notion that after 30 years you could lead the lavish life of a present-day millionaire!
You should always compare the future value of your money with its present value to see its true worth. What is its worth now? For that you need to discount the future value of money to its present value by the expected rate of return on present investments.
Last week I had told how you could know the future value of your present money by compounding it with the expected rate of return.
Discounting is just the opposite of compounding. Financial experts use different mathematical formulas for doing compounding or discounting.
However, if you are not familiar with for ...