Present Value

Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority and you can order it here)

The net amount of discounted expected cash flows relating to an asset or liability.  Stated another way, present value is the principal that must be invested at time period zero to produce the known future value.  The process of converting the future value to the present value is referred to as discounting.  Present value problems can assume this form:  If $1,688.96 is to be received four years in the future, what is its present value if the discount rate is 14%?  The present value in this illustration can be computed by using the following formula:

where pv = present value of any given future amount due in the future

      f  =  a future amount
      i  =  interest rate
      n  =  number of periods.

The present value of $1,688.96 received at the end of four years discounted at 14% is $1,000 calculated as follows:

The present value of an annuity is the amount that must be invested now and, if left to earn compound interest, will provide for the receipt or payment of a series of equal rents at regular intervals.  Over a period of time, the present value balance increases periodically for interest and decreases periodically for each rent paid or received.

Tables are available that make present value computations relatively easy.

BIBLIOGRAPHY

WOELFEL, CHARLES J.  Financial Managers Desktop Reference to Money, Time, Interest and Yield.  Probus, Chicago , 1986.
WOOLRDIGE, J., and SHUEY, K.  “Floating Rate Preferred Stock An Innovation in Bank Capital.”  The Bankers Magazine, May/June, 1983.  

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