Present Value

Published Jan 19, 2023

Definition of Present Value

Present Value (PV) is a financial concept that describes the current value of a future sum of money or stream of cash flows. That means it is a way to measure the value of money today compared to a future date. To calculate the present value (PV), you need to know the future value (FV), the interest rate (r), and the number of periods until the future date (n). More specifically, it can be calculated using the following formula: PV = FV*(1/[1+r]^n).

Example

To illustrate this concept, let’s assume you are offered a job that pays you USD 10,000 in one year. That means you will receive the money exactly one year from now. Now, if the interest rate is 5%, the present value of this future sum of money is USD 9,523.81 (i.e., 10,000*1/1.05^1). That means you would need USD 9,523.81 today and invest it at 5% interest over the next year, to get the same amount of money. Thus, the present value of the USD 10,000 is USD 9,523.81.

Why Present Value Matters

Present Value is an important concept for investors because it allows them to compare different investments and make informed decisions. If an investor is offered two different investments with the same future value but different interest rates, he can use the present value to determine which one is more profitable. In addition to that, present value is also used to calculate the net present value (NPV) of a project, which is a measure of its profitability. Thus, it is an important tool for financial decision-making in general.