Discounted Value Calculator
Determine the current worth of a future sum of money.
Estimated Present Value
$0.00What is Discounted Value?
The Discounted Value, often referred to as Present Value (PV), is a financial concept that determines how much a future sum of money is worth today. This calculation is a cornerstone of the Time Value of Money (TVM) principle, which suggests that a dollar today is worth more than a dollar tomorrow due to its potential earning capacity.
By applying a discount rate, you effectively reverse the compounding process. This allows investors and business owners to compare cash flows occurring at different times on a level playing field.
Where:
- PV: Present Value (Discounted Value)
- FV: Future Value
- r: Discount Rate (expressed as a decimal)
- n: Number of periods (years)
Why Calculate the Discounted Value?
Understanding the discounted value is essential for several reasons:
- Investment Appraisal: Assessing whether a future return justifies the initial capital outlay.
- Business Valuation: Determining the current price of a company based on its projected future earnings.
- Inflation Protection: Calculating how much purchasing power a specific amount will lose over time.
- Debt Management: Evaluating the true cost of long-term liabilities.
Realistic Example
Suppose you are offered a contract that will pay you $50,000 in exactly 5 years. If you believe you could earn 7% interest annually by investing that money elsewhere, what is that contract worth to you right now?
Using the formula: $50,000 / (1 + 0.07)^5 = $35,649.31.
This means that receiving $35,649.31 today is financially equivalent to receiving $50,000 in five years, assuming a 7% return.
How to Choose a Discount Rate
The "Discount Rate" used in the calculation can vary based on the context:
1. Opportunity Cost
The most common rate used is the return you could earn on an alternative investment with similar risk. If you could put money in a savings account at 4%, your discount rate should be at least 4%.
2. Weighted Average Cost of Capital (WACC)
Businesses often use WACC as their discount rate. This represents the average cost a company pays to finance its assets through equity and debt.
3. Inflation Rate
If you simply want to see the future value in terms of today's purchasing power, you might use the expected annual inflation rate as your discount factor.
Frequently Asked Questions
Does a higher discount rate increase or decrease the present value?
A higher discount rate decreases the present value. This is because a higher rate implies that money has a higher earning potential elsewhere, making future payments less valuable today.
Can I use this for monthly periods?
Yes, but you must ensure consistency. If your periods are months, your discount rate must also be a monthly rate (Annual Rate divided by 12).