Peddling Present Value

Eric Knowles

Through the years with my job as an economic expert, I have had to answer the question, ‘what is present value’, many times. The most challenging is when I am sitting in front of a jury of regular people and an attorney asks me to explain the concept of present value. In short, these people have just recognized that they are about to be bored to death.

When an attorney asks me the question of what present value is, I quickly respond with a rhetorical question to the jury.  “Let’s say you get a phone call from the Washington State Lottery Department: you’ve won the lottery! You have two options: 1. receive your money now or 2. five years from now.” Your immediate reaction is to say: “I want the money now. What’s the next step?”

Implicitly you know the right answer. You know that money now is worth more than money received later.  This is, essentially, present value.  If we have the money today what can we immediately do? We can spend it, or not spend it. If we curtail our spending habit for a time, we have the obvious option of putting the money into the bank. The bank gives us money in order to have our money for a time period. Those funds received, known as interest, represent the ‘value of time’. Because if we don’t spend the money, we receive additional money for a specific period.”

The next step is easy. We now recognize that having $10,000 now is worth more than getting $10,000 a year from now. The present value estimate simply attaches finite numbers to the calculation. Let’s reverse the process and ask:

“What is today’s present value of $10,000 that will be received one year from now”?

As we have discussed, time has value. The present value today of an amount to be received one year from today is the amount needed to invest now such that you will have $10,000 in one year. If we assume that the bank will give us 3% per year to invest our funds, we then can easily estimate that the present value, today, of $10,000 one year from now, is equal to $9,700. Each year in the future, the value of a current finite amount is reduced by that 3% figure (assuming the 3% figure is a relevant number). Today’s future value of $10,000 to be received two years from now is $9,426 (the amount needed today that would equate to $10,000 at the end of two years from now).

 

The key to a successful presentation to a jury is to reign in the science (here, economics) by focusing on common tasks we all face daily. The final decision makers are obviously the jury. If you focus on relevant real-world examples in your presentation, they not only will understand you, but also be more likely to believe you.

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