On this page is a present value calculator, a term often abbreviated as PV. When dealing with future dollar amounts, a present value is an estimate of the current sum needed to equal some target amount when accounting for various risks.
Future quantities deal with both inflationary (or deflationary) pressures, opportunity costs, and other risks to the value of your final sum. The actual equivalent value of a sum in the future is almost never the same amount as having a lump sum today.
That’s where ‘Present Value‘ comes into play. If you have an return estimate for what you could earn with a lump sum investment today, you can easily estimate what that future value is worth. Alternatively, present value also tells you the amount you would need to invest today if you needed to end up with the final lump sum assuming a given return… just know that forecasting of this sort is never better than an educated guess!
Using the Present Value Calculator
- Future Amount – The amount you will either receive or would like to have at the end of the calculated period.
- Interest Rate Per Year (Discount Rate) – The annual percentage rate investment return you can earn on money today, over the entire period of your investment.
- Number of Years – The total number of years until the future sum is received, or the total number of years until you need a future sum. (You can enter fractional years, such as 6.5)
- Present Value ($) – The amount the future sum is worth today with the assumptions in the input fields.
The Present Value Formula
In the simplest case, let’s say you’re an excellent investor and can get a 10% return on your money in the ‘market’. You have $100 today, and you stay in the market for three years:
Year 1: $110
Year 2: $121
Year 3: $133.10
If I asked you for $100 today, promising to give you $120 at year three… I’d hope you’d turn that down. The reason is because the present value of $120 in three years, if you have alternatives that earn 10%, is actually $90.16. That is to say, the present value of $120 if your time-frame is 3 years and your discount rate is 10% is $90.16.
The general solution comes in this formula:
For the above problem, your sum would be $133.10. Here’s how the math works out:
The present value formula is: C / (1+i)^ n
- C = Future sum
- i = Interest rate (where ‘1’ is 100%)
- n= number of periods
Inputs: $133.10 in 3 years given 10% investment returns
PV = 133.10 / (1+.1)^3
PV = 133.10 / 1.1^3
PV = 133.10 / 1.331
PV = $100.00
and for my generous offer of $120:
Inputs: $120.00 in 3 years given you could get 10% investment returns elsewhere
PV = 120 / (1+.1)^3 = $90.16
I hope you’d agree – if you can make 10% a year you should turn down my offer of $120 in three years for $100 today.
Using the Present Value Formula and Calculator to Value Investments and Tradeoffs
While we’re insinuating that 10% is an unreasonable estimate for a discount rate, the truth is that there will always be tradeoffs whenever you’re dealing with uncertainty and sums in the future. For the investment part, take a look at our Dow Jones Return Calculator – it notes that after dividends and inflation are factored in, you would have seen about a 10% return, ignoring taxes and fees, since the Dow Jones Industrial Average has existed. (Remember, only adjust for inflation if you also adjust the final amount for inflation as well! It’s least confusing to assume nominal amounts and returns.) We’re not sure if that’s an accurate return estimate going forward, but please form your own estimate.
Regardless of the number you pick, whenever you forego money today, you’re giving something up in the future – even if you’re only able to make 1% on your money reliably. And, yes, in an era of negative interest rates on many Government securities it’s possible that a return of capital may be more important than a return on capital… in that sort of scenario money in the future would be worth more than today.
Another time to evaluate present value, other than when evaluating investments, is when evaluating job offers.
Many of you readers are in industries which have some sort of equity or variable compensation in your annual income. Any true accounting of an offer evaluates your compensation other than salary, such as stock, options, or bonuses with some sort of a present value calculation. Bonuses are first to go in a recession, options can go to zero (especially in early stage companies) and stock can go up, down.. or even to zero. Those future values actually have a range of possible values… some of them zero. Every dollar of salary, in that sense, is more valuable than variable compensation… although it doesn’t have the upside, it is safer than most other options. When using the present value calculator you can adjust for that uncertainty by reducing the amount of future value and running the numbers again.
We hope you enjoyed this brief look at evaluating investments using the present value, and hope you’ll continue to keep this concept in mind as you evaluate your options going forward. You may also enjoy our recent Compound Annual Growth Rate calculator.
Good luck out there!