Present value

Definition

Present value is the current worth of a future sum of money or stream of cash flows given a specified rate of return. It allows for the valuation of future sums in today's terms by accounting for the time value of money.

5 Must Know Facts For Your Next Test

1. Present value calculations are crucial in capital budgeting decisions to compare different investment options.
2. The formula for present value is PV = FV / (1 + r)^n, where FV is future value, r is the discount rate, and n is the number of periods.
3. A higher discount rate results in a lower present value, reflecting greater opportunity cost and risk.
4. Present value helps in assessing the profitability and feasibility of long-term projects by translating future cash flows into current dollars.
5. Net Present Value (NPV) uses present value to determine the difference between the present value of cash inflows and outflows over a period.

Review Questions

• What factors influence the calculation of present value?
• How does an increase in the discount rate affect the present value?
• Why is present value important in capital budgeting decisions?

Related terms

Future Value:

The amount of money that an investment will grow to over a period at a given interest rate.

Discount Rate:

The interest rate used to discount future cash flows to their present values.

Net Present Value (NPV):

A method used in capital budgeting to evaluate investments by comparing the present value of cash inflows with outflows.