I was reading other people’s blog posts today and stumbled upon this article by Fred Ho, Would you choose $1000 today or $1013 in a year?
In his article, Fred explains he preferred to have $1200 in a year rather than $1000 today because of inflation (about 3% a year in Canada). He considers that $1000 today is worth the same as $1030 next year, ceteris paribus ; as such, any offer above $1030 should be taken.
While this makes sense, and if I understood the article correctly, it does not take into account the main point of the concept of present value. Present value is simply the value of a given amount at a set t time in the future for a set i interest. It is very used in finance, for instance when calculating bond value, because a company that issues a bond only knows how much it will pay for the bond, not how much it will get for it. As such, if I’m given $10000 in one year and want an 8% interest, I will buy it for about $9259.
Thus, the point of present value as I understand it is simply to obtain initial investment required to get a given sum of money for a given interest. That’s why it doesn’t take inflation into account. For that reason, I don’t think it should be used in examples such as “Should I take $1000 now or $1200 in a year?” because such a question involves many other factors than simple interest calculations.