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## Appendix F Present Value Calculation

In simple terms, a dollar received in the future is worth less than a dollar received today. One reason for this is inflation—a general increase in the prices of all goods and services. Suppose we assume, however, that there is no inflation or, equivalently that amounts measured in nominal (sometimes called current) dollars are converted into amounts measured in real (sometimes called constant) dollars. Individuals would still prefer a real (inflation-adjusted) dollar today to a real dollar in the future.

There are two main reasons. First, today’s dollar could be invested and would yield a positive real return, thereby providing the opportunity to buy more goods in the future. Second, all things being equal, individuals would rather consume now than in the future. This means that the value of a dollar received in the future is discounted relative to a dollar received now. Mathematically, the present value, PV, of \$1 received in one year is

where i is the appropriate real discount rate; it might, for example, reflect a company’s real return on investment or an individual’s real saving rate. The present value of \$1 received in n years’ time is

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