Enter the timeline of future cash flows and an applicable discount rate into the calculator to determine the present discounted value.
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Present Discounted Value Formula
The following equation is used to calculate the Present Discounted Value.
PDV = ∑(CFₜ / (1 + r)⁽ᵗ⁾)
- Where PDV is the present discounted value ($)
- CFₜ is the cash flow at time t ($)
- r is the discount rate (decimal)
- t is the time period
To calculate the present discounted value, sum each future cash flow discounted by the discount rate raised to the appropriate time period.
What is a Present Discounted Value?
Definition:
A present discounted value is the current worth of future cash flows, recognizing that a dollar received in the future is less valuable than a dollar received today due to the time value of money.
How to Calculate Present Discounted Value?
Example Problem:
The following example outlines the steps and information needed to calculate the Present Discounted Value.
First, determine the future cash flows. In this example, there are three payments: $500 in 1 year, $600 in 2 years, and $700 in 3 years.
Next, determine the discount rate. In this case, the discount rate is 5% (0.05).
Finally, calculate the present discounted value using the formula above:
PDV = (500 / (1 + 0.05)^1) + (600 / (1 + 0.05)^2) + (700 / (1 + 0.05)^3)
PDV = 476.19 + 544.22 + 604.99
PDV ≈ $1,625.40
FAQ
Why is money in the future worth less than money today?
This is due to the time value of money, which factors in potential inflation and opportunity costs of not having the money available earlier for investment or other uses.
How do I choose a discount rate?
The discount rate can be based on various factors, such as the risk-free rate of return (e.g., government bonds), the cost of capital for a firm, or the perceived risk of the cash flows.
Can the present discounted value formula handle varying cash flows over time?
Yes. Simply apply the formula to each unique cash flow at its respective time period and add the discounted amounts together.