The PV Formula calculates the Present Value Interest rate, which is the rate used to determine the present-day value of a sum of money to be received sometime in the future. The total sum of an amount of money that is set to be received at some future date must take into account the "discount rate" or the value of that same money over time. This factors in the rate of return that can be earned on a sum of money over time, and relates to the idea of the time value of money.
How Do You Calculate PV Factor?
There is a formula to calculate the PV factor for a sum of money that is set to be received sometime in the future. The Present Value formula takes into account the discount rate and applies it to the future sum of money. What you are left with is the amount that you must subtract from the total future sum in order to assess its present value.
For example, suppose that Family Corporation knows it will be receiving a $10,000 capital gain in five years. The company wants to begin planning the expenditures it will take on with that money, but it needs to know exactly how much it can spend. Based on the time value of money, $10,000 five years from now is not the same amount as $10,000 is today. It is less. Family Corporation knows they are going to receive $10,000 and they also know that the discount rate is currently 5 percent. By applying the Present Value Formula, they can see how much less that future $10,000 translates to in today's value.
The PV Formula is PVIF = a / (1 + r) ^ n
The PVIF or Present Value Interest Factor is the amount Family Corporation needs to subtract from $10,000 so they can see how much that money is worth at the present time.
(a) indicates the future sum to be received, which in this case is $10,000.
(r) represents the current discount rate.
(n) represents the number of years until the sum is received.
Given the information we have, the Family Corporation's formula will look like this:
PVIF = 10,000/ (1 + .05)^5
The result or PVIF is $1,904.76. Therefore, the $10,000 Family Corporation will receive in five years is equivalent to $10,000 less $1,904.76 today, making the Present Value of that money $8,095.24.
Why is the PV Formula Important?
The PV Formula is important because it allows for an understanding of the way money changes over time which can help companies, businesses and individuals prepare for investments in a less risky way. Companies who have a projected budget for projects or for gains in the future need to calculate the Present Value factor to ensure they don't overspend or overbudget the money they have coming in.
What is PV Formula in Excel?
Excel has a dedicated PV function for calculating the Present Value of any investment. The Excel syntax for PV Formula is PV( rate, nper, [pmt], [fv], [type] ).