Do Present Value Really Helps to Find Over-Appraisal of Profits

PV = C1 ÷ (1 + r)n

C1 = Cash Flow at period 1
r = rate of return
n = number of periods

Present value formula, sometimes also referred to as PVformula is utilized to calculate the value of money at present day which isexpected to be received in future. The underlying concept for this formula is‘time value of money’.

The underlying concept at the time value of money is that if you receive an amount of money at the present day it will worth more rather if received at any future date. The premise is that to receive \$10 today is preferable rather receive \$10 after 1 year in future on the same date. However, if there is a situation where a person is offered \$100 at present day and \$110 at a future date then a calculation is required to determine which one is a better deal. Here present value formula comes-in where you can get a quantifiable comparison between such investments.

How present value formula is useful

Present value formula is used widely in cost analysis, budgetingand evaluating investment opportunities. A more wide range of use can be seenin banking, corporate finance, and investment finance industries. A moreeffective and productive way of present value formula use can be seen within amix of other financial formulas.

Present value formula illustration

Let’s suppose that if a company is investing in a moneymarket account and want to receive \$10,000 at maturity of account after twoyears with 6% profit (simple interest) annually.

The company wants to know the present value of money it isgoing to receive at maturity of the account. While putting the values in theformula we get;

PV = \$10,000 ÷ (1.06)2

The sum of money which must be investedtoday is \$8,899.96 to get the value of \$10,000 as an ending balance.

Is there an alternative to present value formula

Present value formula can also berepresented as;

PV = FV [1 ÷ (1 + r)n]

FV = Future value

r = rate of return

n = number of periods