What is present value?
Present value tells you what a future amount of money is worth today. Money you receive later is worth less than money in hand, because today's dollars can be invested and earn interest. The formula is:
Present value = future amount ÷ (1 + rate)years
At 5% a year, $10,000 received in 10 years is worth about $6,139 today. You can also add a payment at the end of each year to value a stream of income, such as a settlement, lease or annuity.
When present value helps
- Comparing a lump-sum prize or settlement with payments over time.
- Deciding how much to invest today to reach a future goal.
- Valuing a pension, a bond or the rent from a property.
The rate you choose matters a lot. Use the return you could earn elsewhere with similar risk.
Frequently asked questions
What discount rate should I use?
Use the return on your best alternative with similar risk: a savings or CD rate for safe money, or an expected investment return for riskier choices.
What is the difference between present value and NPV?
Net present value subtracts what you pay today from the present value of what you receive. A positive NPV means the deal is worth more than it costs.
Does compounding frequency change the answer?
Slightly. Monthly or daily compounding gives a slightly higher effective rate than yearly compounding, so the present value is a little lower.