Present Value
The time value of money principle says that future dollars are not worth as much as dollars today.
We can compare present and future values with a rather simple equation.
(1)
This will give you the present value of a single future cash flow (FV) . In fact for ease down the road we
will generally use CF instead of FV. Future Value (FV) will be reserved for when we are actually solving
for a future value. (For example how much will we have in 5 years). A simple Present Value example
follows:
What is the present value of $8,000 to be paid at the end of three years if the correct (risk adjusted interest
rate) is 11%?
(2)
= 8,000/(1.11)
3
= 8,000/1.36
=$5,849
Note that if you had so desired you could write this equation as
(3) PV = CF * (1/(1+r)
t
)
Which would be:
PV = 8,000 * (1/1.11)
3
)
=8,000 * .7312
= $5,849
The second term in equation 3, (1/(1+r)
t
), is known as the present value discount factor or present value
interest factor. It is usually abbreviated PVIF(r%, N periods). You can find this number either
mathematically or from present value tables. Specifically this is the present value of a dollar and can be
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found on table A1. (Note the higher the required interest rate, i.e. the more risk, the lower the present
value.)
Continuing our example, suppose that you were willing to make a loan where you would get $8,000 back
at the end of the third year, and $10,000 at the end of the fourth year. What is the present value of this?
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 Spring '11
 P.Ramanlal
 Finance, Time Value Of Money, Future Value

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