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 discounts future amounts to reflect the time value of money.

5 Must Know Facts For Your Next Test

1. Present value calculations are crucial for evaluating investment opportunities.
2. The discount rate used in present value calculations reflects the risk and opportunity cost.
3. Present value decreases as the discount rate increases.
4. For multiple unequal payments, each cash flow must be discounted individually before summing them up.
5. Understanding present value is key for comparing cash flows occurring at different times.

Review Questions

• How does an increase in the discount rate affect present value?
• Why is it important to calculate the present value of multiple unequal future payments separately?
• What role does the discount rate play in determining present value?

Related terms

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

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

Net Present Value (NPV): The difference between the present value of cash inflows and outflows over a period of time.