It simply means the current worth of future sum of money. The future sum of money can be either single payment or a series of cash flows given a specific rate of return.
This concept uses the ‘time value of money’ which says money has different values at different points in time.
Simple formula of calculating present value for a single future payment,
Present Value (PV) = Future Value (FV) / (1+r) n
FV=Cash-flow in future
r=rate of return (interest rate)
n=number of years.
Caution: The formula does not apply to a series of future cash-flows (annuities).
Example: Let’s say you want Rs 1100 after one year. How much you should invest today (in other words what is the present value of Rs 1100) if the rate of interest is 10%.
PV = 1100 / (1+0.01)1 = 1000
So if you invest today Rs 1000, you will receive Rs 1100 after one year.
The concept of present value is one of the most fundamental concept in the world of finance. It is the basis for many important concepts in Finance.
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