Present value - Financial definition
Financial acronyms
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Concise definition of the term present value
The term present value describes the current value of a cash amount or of a series of cash flows to be paid or received in the future. It is obtained by discounting the amount or the cash flows at a given rate of return.
Comprehensive definition of the term present value
The price of a bond is an example of where present value calculations come to use. A bond's dirty price is in fact simply the sum of the present values of its future cash flows, discounted at its current market yield.
The actual present value of a given cash amount or a series of cash flows is influenced by:
- The interest rate applied
The higher the interest rate, the lower the present value of the amount or cash flows will be - The discounting frequency
The higher the discounting frequency, the lower the present value of the amount or cash flows will be
Examples:
No compounding:
A sum of 10 000 € to be received in 5 years, generating a simple annual interest of 3%, would have a present value of 8 695.65 € ( = 10 000€ / (1 + 5 x 3% ) )
Annual compounding:
A sum of 10 000 € to be received in 5 years, generating an interest of 3% compounded annually would have a present value of 8 626.09 € ( = 10 000€ / (1 + 3%)^5 )
Monthly compounding:
A sum of 10 000 € to be received in 5 years and generating an interest of 3% compounded monthly would have a present value of 8 608.69 € ( = 10 000€ / (1 + 3%/12)^(5x12) )
The future value calculation is the opposite of the present value calculation, where the future value of a cash amount or a series of cash flows is determined.