1 Hypothetical Situation... Suppose you win the Publisher’s Clearinghouse Sweepstakes and are given a choice of taking $10,000 today or $12,000 three years from today Which should you choose? Re-stated, what is the promise of $12,000 three years from now worth to you today?

2 Present Value Calculations Present value calculation - assessing what a future dollar amount is worth to you today. Present value of a future lump sum – PV Present value of future periodic payments – PVA

3 Present value of a future lump sum... where r = interest rate per period n = number of periods FV = the future value of the investment

4 Back to our example... FV = $12,000 Use r =.08 Get your money in 3 years = $9, Implies that, based on economic considerations, you should take the $10,000 today

5 Present Value of a lump sum Period1%2%3%4%5%6%7%8% $12,000 x.794 = $9,528

6 How do these calculations change if the payment is repeated periodically? Suppose you want to know how much a retirement annuity is worth to you today if it claims… $20,000 annual payment 5 year time period r=.03 Need to calculate the present value of future periodic payments (also called the present value of annuity payments → PVA)

7 Present Value of an Annuity All terms defined as previously Please note: That really is a negative n [-n]

8 Previous Example: $20,000 annual payment 5 year time period r=.03

9 PVA = $91,594.14

10 Present value of an annuity Period1%2%3%4%5%6%7%8% $20,000 x = $91,600

11 Let’s try it some more... Your work is offering an incentive for you to retire early. Should you take $500,000 now or $30,000 per year for the next 20 years? PVA PVA = $446, So, take the $500,000 now

12 Present Value of an Annuity Period1%2%3%4%5% $30,000 x = $446,310

13 The Only Two Certainties in Life are Death and Taxes Costs and benefits of alternative resource allocation options should only be assessed net of taxes. Some choices of how to spend resources are nontaxable and therefore they are worth more than taxable options. Some choices reduce your amount of taxable income while others do not.

14 Example Finance the purchase of a car using… a 7% loan from your credit union, or a 7% home equity loan On the surface, the financing options appear to be equivalent, but interest paid on a home equity loan can be deducted from taxable income while interest paid on a credit union loan cannot.

Federal Tax Rates – Single Income betweenMarginal Tax Bracket $0 - $8,35010% $8,351 - $33,95015% $33,951 - $82,25025% $82,251 - $171,55028% $171,551 - $372,95033% > $372,95135%

Federal Tax Rates – Married Filing Jointly Income betweenMarginal Tax Bracket $0 - $16,70010% $16,701 - $67,90015% $67,901 - $137,05025% $137,051 - $208,85028% $208,851 - $372,95033% > $372,95135%

17 Example-Assume a $30,000 vehicle with a 5 year loan at 7% 1 st year interest = $1, nd year interest = $1, rd year interest = $ th year interest = $ th year interest = $ Total interest = $3, Tax savings = 10% : $ % : $ % : $ % : $1, % : $1, % : $1,429.35

18 Federal Tax Brackets

19 A Bird in the Hand is (sometimes) Better than two in the Bush The future is riddled with uncertainty future income future inflation But, some resource allocation options involve more risk than others. All other things being equal, households typically like to avoid risk and uncertainty.