Present Value: Definition, Benefits, Formulas, and Calculation Examples

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The value of money will always change from year to year, influenced by many factors. Therefore, we need to know more about present value. 

This present value will provide an overview of the value or value of money that you have now in the future. 

To know the current value and its uses, see the following summary of wannawishyou!

Definition of Present Value

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Present value is the current value of a certain amount of money or cash flow that you will have in the future, with a specific rate of return or rate of return quoted from Investopedia.

Simply put, The Balance defines present value as the value of the amount of money in the future calculated from the current value of money with interest. 

Furthermore, citing Investopedia, the present value states that the money we have now will not be the same in the future. 

For example, if you have IDR 1 million now, the value of that money will not be the same in the next 5 years, let alone for the next 10 years. 

4 Benefits of Understanding Present Value

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When deciding to invest, you must be able to calculate the present value or also called this PV.

In addition to the investment, the value of money or the time-value of cash that investors can reduce is also a consideration for understanding PV. 

Suppose there is an increase in the price of goods and services, and the ability to pay decreases. This is what causes the value of the money saved to decrease. 

When investing, you certainly don’t want to lose. If you invest IDR 3 million, of course, the hope is that you will get more than that value in the next 3-5 years.

Present value considers the interest rate and the probability that each investment will earn.

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In addition, as reported by WallStreetMojo, there are at least four things that make present value essential to understand:

1. Business Analysis

In running a business, it is crucial that you first understand what cash inflow and outflow are.

PV calculations are needed to estimate future cash flows at certain levels.

2. Basic/fundamental concepts

Investments such as stocks, deposits, and insurance require a present value calculation.

Investment is an activity that is full of risk. If you don’t understand it well, you can lose. 

3. Time-value of money

PV calculation is needed to estimate the value of money in specific periods before investing.

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4. Preparing for Inflation

According to Bank Indonesia, inflation is an increase in the prices of goods and services in general and continuously within a certain period.

Inflation will affect your finances; the PV calculation includes a specific period or period. 

Present Value Calculation Formula

Calculating the PV value can be done in several ways; some are using a table of values or using PV calculations in Excel.

You can also search and calculate it online because many provide PV calculators. 

However, in general, the formula for calculating the present value is as follows:

PV = FV/(1+r)^n

Information:

FV: future value 

r: rate of return or  rate of return

n: period (time)

Future value is the value of the assets you own at a particular time in the future based on the assumption of a growth rate. 

You can calculate this FV equation by assuming a consistent growth rate.

Usually, this calculation will allow investors to make predictions with various levels of accuracy.

The amount of profit obtained can also be predicted according to the investment type.

Meanwhile, the rate of return, as explained a little above, is a specific rate of return on investment. 

In this PV calculation, the rate of return is called the discount rate.

Example of Calculation of Present Value

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wannawishyou will explain it with case examples. For example, you want to prepare a vacation with your family for the next 2 years.

After the calculations, it turns out that you need a total of USD. 20 million.

If you place funds in a bank with an interest rate (rate of turn) of 2% per year, how much should you prepare now?

This means you have to determine the PV of the money you have for the next 2 years according to the formula above then:

PV = FV/(1+r)^n

= USD20 million / (1+0.02)^2
= USD20 million / (1.0404)
= USD19.2 million

By saving your bank deposit funds, you can reach your target of USD 20 million within two years.

You must understand basic things about the present value or PVands examples of calculations.

If you want to try investing or saving money, first understand the basics to know what to do. 

You can also visit the wannawishyou blog to learn more about investing and finance.

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alok
Alok kumar is an Indian content creator who is currently working with many world wide known bloggers to help theme deliver the very useful and relevant content with simplest ways possible to their visitors.

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