1. Present value
Hello! And welcome back to Financial Analysis in Power BI. Previously, we learned about the time value of money and future value. Now we'll learn about present value.
2. Present value (PV)
Present value is the current value of money that will be received in the future. Another way to think about the present value is to ask, "How much do I need to invest today to have the equivalent of the future value by the end of the time period?"
Finding the present value of money is often referred to as discounting.
Remember that cash tomorrow is not as valuable as cash today, so the present value formula discounts the future value by reducing it. This is why the interest rate in the present value formula is called a discount rate.
Looking at the formula, as the discount rate or number of years increase, the denominator increases. Since future value is divided by the denominator, a higher denominator would result in a lower present value.
Let's look at an example. To find the present value of $500,000 ten years from now at a 20% discount rate that compounds weekly, first we would take the formula, then plug in the numbers like this, and solve for PV. By the end, we find that it's only worth $67,927 and 73 cents in today's money.
What that also means is if we took that same amount of money and invested it at 20% over ten years compounded weekly, it would be worth $500,000. The math for present value and future value line up, as they are just the inverse of each other.
3. Annuities
Recall that annuities are fixed amounts paid in regular intervals. Because annuities are cash flows received in the future, we can find the present value of these cash flows.
Let's look at this is annuity of four $500 payments.
4. Annuities
The present value annuity formula discounts each payment by its respective number of years, then adds up all the discounted cash flows together to find what it's worth today.
5. Annuities
So after setting up the equation like this, we can see that it is really just a series of present value calculations.
6. Annuities
So now we being to solve...
7. Annuities
And we'll find that the present value of this annuity is $1,772 and 98 cents.
8. Let's practice!
Now that you're familiar with present value, it's time to test your knowledge.