As when you first saw the definition of future value, this definition of present value may not make much sense, but let's break it down a bit.
To understand this better, it actually helps to compare it to future value. For future value, you start with what you have, multiply it by an interest rate, and see what it is worth at some point in the future. For present value, you actually start with the future sum (which is not what you have, but what you want to have), reduce it by an interest rate and see how much you must have today to reach that future goal. As an example, if you would like to have $10.40 one year from now, and you agree that 4% simple interest is a fair rate of return for waiting one year to spend your money, then the appropriate calculation would tell you that you need $10.00 today in order to have $10.40 in the future.
Let's use that example to look at our definition again:
In this scenario, our future (one year from now) sum of money ($10.40) has a present value of $10.00. It makes a little more sense once you put it in context!
Another way to understand present value is to ask yourself the following question:
- How much money do I have to have today to have $4,674 in fifteen years, if being paid 4% interest?
- How much money do I have to have today to have $438,000 in 50 years, if being paid 8% interest?
And that's what this lesson is about. By the end of this lesson, you'll be able to calculate the present value of any sum of money you'd like to have in the future. Click Next to begin.