In this appendix we will show how you can expand the use of present value calculations to understand how businesses make investment spending decisions and how investors determine the prices of existing financial assets like stocks and bonds. We begin by showing how to apply present value calculations for one-year and multi-year projects. Then we show how to calculate the present value of a project that has revenues and costs arising in the future. Finally, we use present value to calculate the prices of financial assets like bonds and stocks.

The key point to keep in mind is that when businesses engage in investment spending, the lower the equilibrium interest rate, the greater the payoff from a project, other things equal. As a result, when the interest rate falls, more businesses will spend on investment projects. Likewise, consider an existing financial asset like a stock or bond that promises to deliver payments to its owner in the future. When the equilibrium interest rate falls, the value today of those promised future payments goes up. As a result, the prices of those existing financial assets will rise in financial markets.