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What is Present Value?

By Bruce T.
Updated May 17, 2024
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A core principal of finance, known as the time value of money (TVM), is based on the concept that $100 US Dollars (USD) in the present is worth more than having $100 (USD) a year later. This is because someone could currently invest it and have it earning an additional income during the course of the year; also, this is the basis for present value (PV). For example, investing $1,000 USD at a five percent interest rate over the course of one year would become $1050 USD. If the $1,000 USD were received one year from the present date, it would have to be discounted by the five percent interest rate — it would be $952.38 USD, which is determined by the equation $1,000 USD ÷ 1.05. This is what is known as the present value of $1,000 USD at a discount rate of five percent.

The formula used to calculate for present value is PV = P/〖(1+i)〗^n. P stands for the principal, or cash; i equals the discount rate; and n represents the number of periods. Therefore, the values from the previous example plugged into this formula would be PV = $1,000 USD /〖(1.05)〗^1 = $952.38 USD.

To facilitate finding the present value of many values, this formula has been used to create present value tables. The amount of principal used in the formula typically is $1.00 USD. A decimal that this produces can be applied to any amount of money for a designated discount rate and is known as the present value interest factor (PVIF). The formula for this would be PVIF = $1.00 USD / (1.05) = .95238. This particular PVIF can be applied to any amount of principal for a time period of one year at a discount rate of five percent; for example, $1,000 USD x .95238 = $952.38 USD, and $4,500 USD x .95238 = $4285.71 USD.

Present value calculations are used in many ways for transacting business. They can help a person make a decision on automobile financing, paying mortgage points, or buying a business. In the financial sector, PV helps to determine spot rates on currency exchanges and value income streams from securities or real estate.

WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
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