Present Value Definition, Calculator and Examples.
Present value is economic model that calculates the present
value of a money that will be paid in future. This because the dollar today
worth more than a dollar tomorrow. In other word, there is a time value of
money. The main theory of the background of this model is if you have a money
now, you can invest in different instruments like a share of a company,
interest, etc. therefore, if you invest your money in instrument, you will have
more money in future than you have now. With respectively, if you will receive
a money or pay money in future, today value for that amount will be lower.
The present value calculates the today value of future cash
flows. Generally, interest rate that you will used for calculating present
value.
- Formula of present value.
The below formula is the present value formula,
PV= FV / (1 + r )n
Which:
PV = present value.
FV = future value
r = interest rate
n = number of periods.
- Example of present value calculate.
Let us assume that your project has three instalments:
1st instalment : $ 100000 (that will be paid in
the beginning)
2nd instalment : $ 100000 (that will be paid at
the end of 1st year)
3rd instalment : $ 100000 (that will be paid at
the end of 2nd year)
Interest rate (r) = 10 % per year.
Let us calculate the present value of these instalments.
Since the 1st instalment is paid at the beginning
of the project, the present value will be the same of actual value.
1st installment’s PV = FV / (1 + r )n = 100000 / (1+ 0.10)0 =
100000 $
Then the 2nd instalment will be paid at the end
of the 1st year,
2nd instalment’s PV = FV / (1 + r )n = 100000 / (1+ 0.10)1 =
90909 $
3rd instalment will be paid at the end of 2nd
year,
3rd instalment’s PV = FV / (1 + r )n = 100000 / (1+ 0.10)2 =
82645 $
Briefly, the total money that will be retrieved from the
customer is 300000 $ in total. Since it will be retrieved over time, present
value or in other word today’s value of these instalments is:
100000 + 90909 + 82645 = 273534 $.