Present Value
Present value (PV) is the amount that a future cash flow is worth today, found by discounting it at a chosen rate. Because money can earn a return over time, a dollar received in the future is worth less than a dollar held now. PV reverses compounding: it tells you how much you would need to invest today to reach a given future amount.
Worked example
You will receive $1,000 in 3 years and the discount rate is 5%. PV = 1,000 ÷ (1 + 0.05)³ = 1,000 ÷ 1.157625 = $863.84. So $863.84 invested today at 5% grows to $1,000 in three years.
Why it matters
Present value is the foundation of nearly every valuation method, from bond pricing to discounted cash flow analysis, because it lets you compare cash flows arriving at different times on a common basis. The most common pitfall is choosing the wrong discount rate: a rate that is too low overstates present value, while too high a rate understates it.
Frequently asked questions
What is the difference between present value and future value?
Present value tells you what a future amount is worth today, while future value tells you what a today's amount will grow to later. They are two sides of the same time-value-of-money relationship, linked by the discount or growth rate.
Does a higher discount rate raise or lower present value?
A higher discount rate lowers present value, because each future cash flow is divided by a larger factor. Lower rates raise present value.
Related terms: Future Value, Discount Rate, Net Present Value (NPV)