Present Value and Future Value
What They Are And Why You Should Care

Understanding present value and future value of money is of utmost importance in finance. Many of us have heard of present value, future value, interest rate, time value of money, and discounted cash flow. While these terms might seem like jargon to you, they play a vital role in decision-making in financial and investing fields.

They help investors make objective decisions when all factors are considered. However, it’s easy to get lost in the sea of financial terms if you’re not familiar with them. This blog will give you a comprehensive understanding of present value and future value of money so that you can make wiser decisions in your finances. We will also talk about the time value of money and discounted cash flow, which are vital concepts if you want to be an expert when it comes to money handling.

Understanding present value and future value of money is of utmost importance in finance. Many of us have heard of present value, future value, interest rate, time value of money, and discounted cash flow. While these terms might seem like jargon to you, they play a vital role in decision-making in financial and investing fields.

They help investors make objective decisions when all factors are considered. However, it’s easy to get lost in the sea of financial terms if you’re not familiar with them. This blog will give you a comprehensive understanding of present value and future value of money so that you can make wiser decisions in your finances. We will also talk about the time value of money and discounted cash flow, which are vital concepts if you want to be an expert when it comes to money handling.

Difference Between Present Value and Future Value

There is a lot of confusion surrounding present value and future value. This is understandable considering how vital each of these calculations is to financial decisions. But knowing the difference between the two can help you make better decisions.

The present value(PV) of an amount equals the value of that same amount today multiplied by the interest rate that has been applied to the value of that amount today. The present value calculation determines the amount you'd receive if you invested that amount today.

Future value(FV), on the other hand, is the value of an investment after all interest and other earnings are taken into account. It's calculated by multiplying the amount by interest rate and adding the value of all future earnings/values.

In financial decisions, present value is used when making decisions regarding investments with a time frame shorter than one year, while future value is used in situations involving longer times such as 10 years or more.

When performing a present or future value calculation, it's essential to have a good grasp on what each calculation entails and how to interpret its results.

What Is Present Value?

What is the importance of the present value?

Present value is used to estimate the value of a future cash flow. Discount each future income stream back to the present, and combining them, is how net present value is calculated.

How is present value calculated?

In order to calculate present value, one needs to know a few things about the investment. The discount rate must be known. The investment or project length will need to be used in the calculation. The final thing required is the initial cost of the investment. With these pieces of information, it's possible to calculate present value.

Benefits of Knowing the Concept of Present Value

Present value is the value right now of a future sum of money or stream of cash flows given a specified discount rate. In other words, present value is the value of a future sum of money or stream of cash flows today.

By understanding present value, an analyst can make informed decisions on investments and calculate potential returns. It also provides insight into the time value of money, which is the idea that money today is more valuable than an equal amount in the future. By understanding present value, investors can determine their risk tolerance and make more informed decisions about investing.

Example of Present Value Calculation

The concept of present value is the value of money today, taking into account interest earned on that amount and the time value of money. A crucial concept of finance, present value is used to determine the value of future cash flows of a project or investment. It helps determine whether a project or investment is worth making at today's cost. To calculate present value, start with future value of a sum of money (FV) and future interest rate (A). The present value (PV) can be expressed as; the current amount times the interest rate expressed in years times the year of interest.

Using Present Value to Make Investment Decisions

Present value is the value of a future payment or investment today. It is important to understand present value when making investment decisions as it helps you determine the current value of a future payment or investment. Future value is the amount of money that can be expected at some point in the future. Using present and future values together can help you determine whether an investment is worth making.

By comparing present and future values of different investments, you can decide which one will yield the best return. Additionally, understanding present value enables you to make informed decisions about how much money to allocate toward long-term investments as well as short-term loans. When making investment decisions, it's always important to take into account both present and future values, as it helps provide a more thorough look at different options and their relative merits.

Present value is the value of a future payment or investment today. It is important to understand present value when making investment decisions as it helps you determine the current value of a future payment or investment. Future value is the amount of money that can be expected at some point in the future. Using present and future values together can help you determine whether an investment is worth making.

By comparing present and future values of different investments, you can decide which one will yield the best return. Additionally, understanding present value enables you to make informed decisions about how much money to allocate toward long-term investments as well as short-term loans. When making investment decisions, it's always important to take into account both present and future values, as it helps provide a more thorough look at different options and their relative merits.

The Future Value of Money

Money grows because of interest or investment return. That return on your investment begins to earn a return also. That compounded interest is what makes the future value different than the present value.

Example of Future Value

The future value of an investment is the amount earned at the end of a period, assuming interest is paid on the investment. It is calculated by taking the present value of the cash flow of an investment and discounting it using the time value of money formula or future value formula.

To calculate future value of an investment, we must consider interest rate as well as time taken to get return on our money. 

The interest rate used to calculate future value of an asset will depend on its duration and rate of return. The time taken to generate return will also be a factor in deciding interest rate.

Different strategies can be adopted to maximize future value and earnings potential, such as investing in high-interest rate instruments or short-term savings accounts to earn higher interest rate or investing in longer-term assets with higher rate of return.

How to Calculate Future Value

Future value is the value of an investment at some point in the future, typically after a specific time period. It is calculated by taking the present value of the investment and multiplying it by a factor based shooting to the rate of return and length of time for which it is held.

FV = PV x (1+i)^n.   FV = 1000 x (1 + .1)^ 12 = 1000 x3.1834 = 3183.40, where i = 10% and n = 12 years. This calculation gives you an idea of how much money your investment will be worth in five years.

Frequently Asked Questions

What is the relationship between present value and future value?

The future value of money is the amount that a sum of money invested today will grow to over time, given a compound interest rate. The present value is the current worth of a future sum of money or stream of cash flows given a specified rate of return. Future values are important for projecting how much an investment will be worth in the future.

Is current value the same as present value?

The current value is the value of an asset or liability at the present time or what it is worth today. Future value is the value of that same asset or liability at some future date. Present value takes into account factors such as inflation and interest rates, while future value does not.

How can a calculator be used to find PV?

A present value calculator can use the present value formula in Excel to calculate PV.

Why is the time period important?

The time period between compounding effects the rate of increase in value of an investment. A shorter period increases the value.

What is compound interest really?

Compound interest is the interest earned on the interest accrued from previous periods.