What is the time value of money?
A dollar today is worth more than a dollar next year, because today's dollar can earn interest. Present value brings future amounts back to today; future value grows today's amounts forward. Accountants use it to value bonds, leases, notes and investment projects.
The formulas
Worked example
What is $10,000 received in 5 years worth today at 8%? The growth factor is 1.08⁵ = 1.469328, so the present value factor is 0.680583. Present value = $10,000 × 0.680583 = $6,805.83.
Frequently asked questions
What is present value?
Present value is what a future amount of money is worth today, given a rate of return. Money today is worth more than the same amount later because it can be invested.
What is the difference between an ordinary annuity and an annuity due?
In an ordinary annuity, payments happen at the end of each period, like loan payments. In an annuity due, payments happen at the start, like rent. An annuity due is worth more, by a factor of (1 + r).
What if interest compounds monthly?
Divide the annual rate by 12 and multiply the number of years by 12. For example, 6% for 5 years compounded monthly is 0.5% for 60 periods.