What is present value?

Present Value can be understood from the concept of time value of money.

What is time value of money?

- Receiving $1 in the future is worth less than $1 now

- The opportunity cost of $1 in the future is the interest we could have earned on $1 if received earlier

Example 1:

You will receive $100 from a funding account that earns 10% interest per annum (compounded) in three years time.

After one year, you have two years more to receive the $100: $100 / (1+0.1)(1+0.1) = $83

After two years, you have one year more to receive the $100: $100 / (1+0.1) = $91

After three years: $100

For one period:

PV₁ = FV / ( 1 + r )(1 + r) = FV / ( 1 + r ) 2

For two periods:

PV₂ = FV / ( 1 + r ) = PV ( 1 + r ) 1

For n periods:

PV_n = FV / ( 1 + r ) ⁿ

The expression 1/(1 + r)ⁿ is the present value interest factor (PVIF)