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Present Value & Discounting

WHAT IS PRESENT VALUE ?

PV (Present value ) is an important element in the time value of money, which forms the backbone of finance. There can be no such things as mortgages, auto loans, or credit cards without PV.

Present value refers to the current value of the future sum of money, at a specified rate of return. It is the comparable value today of cash sometime in the future.

This concept is important as it allows the investors to determine the future financial benefits of current assets or liabilities which enables them to compare values overtime.

For example, if an investor wants to compare and analyse two different types of investments, he can compare their present values to determine which one offers better returns.

HOW TO CALCULATE PRESENT VALUE ?

The formula for calculating present value is :

Present value = FV/ (1+i)^t

Where,

FV = Future value

i = interest rate

t = number of time periods

WHAT IS DISCOUNTING ? 

Discounting can be defined as the act of estimating the present value of a future payment or a series of cash flows that are to be received in the future . It is considered as a primary factor used in pricing a stream of tomorrow’s cash flows.

It  helps in pricing issues based on the future financial prospects of a company. In the case of bonds, the present market price is determined by discounting the future interest payments.

A discount rate is defined as the rate used to discount future cash flows back to their present value.

Thus , in simple words discounting is the process of determining the present value of a future payment or stream of payments & serves as an effective way to compare  investment decisions, by evaluating future sums of money in the present.

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