Present Value

Present value refers to the current worth of a future sum of money, discounted to reflect its current value based on a specific rate of return or interest over time.

What is Present Value?

The concept of present value (PV) refers to the aggregate value of cash flows within a given stream, taking into account the value of each individual cash flow. The calculation of present value considers the notion that money available today holds more worth than an equivalent amount of money in the future, as current money can be invested and accumulate interest, while future money cannot. Moreover, it considers the risk associated with the cash flow stream, valuing a more certain cash flow higher than one with greater uncertainty.

The significance of knowing your present value-

Understanding the present value of a future cash flow is pivotal - For instance, when contemplating an investment in a project generating future cash flows, knowing its present value aids in assessing its worth against the investment cost. Furthermore, understanding the present value facilitates the calculation of a project's return on investment, a critical metric in evaluating the project's profitability.

Consider the scenario where someone offers $10,000 today or $11,000 a year from now. The present value of $11,000 a year in the future is $10,000 today, as it accounts for the discount due to the time gap between the two cash offers.