Present Value Of Money – Bringing The Future To The Present

By | October 17, 2013

In the world of finance, you’ll hear a lot about the present value of money, and you should know how it works.

Present value of money

Rather than giving you a definition, it is best to give an example. Say you want to spend $1,000 today on a watch. But rather than spend it, you put your money in a bank and earn 8% interest. So this day next year, you have $1,080. Hence, a $1,080 next year is equal to a $1,000 today. That is the basic concept that is used in computing the present value of money – how much is your future money worth at the present? You’ll also sometimes hear of the future value of money, and that is simply the how much your money at the present is worth at the future. To get the present value of money, the formula is simple:

present value of money

=

future cash inflow

(1+interest rate)n

where n=number of years The applicable interest rate is the tricky part. This depends on what you are supposed to do with your money. In the example earlier, you put your money in a bank that earns 8% interest and that was what we used as the interest rate. Suppose you invest it in bonds or in stocks? For companies, one other assumption is if you used it in operations, in which case your “interest rate” is the financial returns the company can offer.  As there are varied ways to invest your money now, we will use the weighted average of them all to get your applicable interest rate. As to the varied ways to invest your money, that’s what this blog is for. So feel free to explore, and see the different ways of growing your money.

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