Business Tips Tricks and Enhancement
Present value is similar to future value in that it represents the value of an investment. However, it calculates the value of money you will receive in the future from the perspective of right now. A dollar today is always worth more than a dollar tomorrow because of the interest you can earn on today’s dollar. This might not make sense right off, so let’s look at a couple of examples.
For instance, suppose you know that you will need $10,000 in five years and you want to put a chunk of money away and let it earn interest to meet that goal. You know you can get a reliable 4% return. How much money do you have to put away now for it to grow to $10,000 in five years?
Here’s another example. Suppose your employer gives you a choice of how to take your annual bonus—either $2,300 in a lump sum now or $200 a month for the next 12 months. You could use a present value calculation to determine the present value of that $200 per month, compare it to the lump sum payment and make your decision accordingly. Simply multiplying $200 per month for a year gives you $2,400, but you cannot say that is better than $2,300 today due to interest you might earn over the next year on today’s $2,300.
As another example, you are looking to buy a new car and have decided that you can afford $290 per month payment for the next five years. Knowing the interest rate available on auto loans, you can use present value to determine the amount you will be able to borrow.
A more intuitive way to look at present value is this. Suppose you invest $X per month at Y% interest. The present value is the lump sum you would have to invest at the same rate to end up with the same total at the end of 12 months.
Taken From : Manage Your Money and Investments with Microsoft Excel
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