The discounted (present) value is an estimate of the amount of profit received in the future from an investment in a particular financial instrument in terms of the current point in time. It allows you to find the amount of investment that is required in order to receive a certain profit after a specified period.
Instructions
Step 1
To understand how to find present value, consider an example. The investor is going to invest in shares. He plans to receive $ 2,000 in a year. The interest rate (yield) is 10%. In order to determine the present value, you need to divide the amount of future income by the interest rate, increased by one. The present value in this example would be $ 1,818 (2,000 / (1 + 0, 1)). Thus, an investor needs to invest $ 1,818 to receive $ 2,000 in a year. Obviously, the higher the interest rate, the less investment will be required, and vice versa, at a lower interest rate, a larger amount must be invested to obtain equal income.
Step 2
You should understand that the discounted value depends not only on the interest rate, but also on the period of investment of funds. Let's say an investor has invested in stocks for a period of 3 years, and not for a year, as indicated in the previous example. In this case, the discounted value for 1 year will be $ 1818, for the second - $ 1652 (1818 / (1 + 0, 1)), for the third - $ 1501 (1652 / (1 + 0, 1)). The discounted value of $ 1501 means that the investor needs to invest this amount in order to receive $ 2000 in 3 years. Thus, the longer the investment period, the less investment will be required.
Step 3
In order to determine the present value for different investment periods and interest rates, use the following formula: P = I / (1 + r) ^ n, where P is the present value; I is the amount of investment; r - interest rate; n - investment period. The need to calculate the discounted value is due to the fact that it allows you to correlate the estimated amount of investment with the expected amount of profit. Based on this, it can be concluded whether it is advisable to invest in the project under consideration.
