Present value of a future cash flow is the amount of current cash.
Discounting is the process of determining present value of a series of future cash flows at time 0.
The interest rate used for discounting cash flows is also called the discount rate.
Calculation of Present Value
Present Value of a Single Cash Flow
Cash Flow at one time only
Present Value of Annuity
Stream of Equal Annual Cash Flows
Present Value of a Single Cash Flow
The below given formula is used to calculate the present value of a lump sum amount to be received after some future periods:
PV = FV (1+r)^n
The term 1/(1+r)^n is the discount factor or present value factor (PVF), and it is always less than 1 indicating that a future amount has a smaller present value.
PV =Fn*PVFn
Present Value of an Annuity (Stream of Equal Annual Cash Flows)
The computation of the present value of an annuity can be written in the following general form:
PVAn = A {(1+r)^n -1 / r(1+r)^n)}
PVA- Present value of an annuity which has a duration of n periods
A-Constant periodic flow
r-Rate of discount (expressed in decimals)
n-Time horizon
The term within parentheses is the present value factor of an annuity of Re 1, which we would call PVFA
P=A* PVAFn,i