Present Value Factor Definition
Present value factor is factor which is used to indicate the present value of cash to be received in future and it works on the basis of time value of money and present value factor is number which is always less than one and which is calculated by one divided by one plus the rate of interest to the power, i.e. number of periods over which payments are to be made.
Present Value factor Formula
- r = rate of return
- n = number of periods
Derivation of Present Value Factor Formula
This is the original formula for the PV factor from which the formula we have presented above is derived.
- Here, FV = Future Value
- r = rate of return
- n = number of periods
Examples
Suppose, if someone were to receive $1000 after 2 years, calculated with a rate of return of 5%. Now, the term or number of periods and the rate of return can be used to calculate the PV factor for this sum of money with the help of the formula described above.
PV factor = 1 / (1+r)n = 1/(1+0.05)2 = 0.907
Now, multiplying the sum of $1000 to be received in the future by this PV factor, we get:
$1000 x 0.907 = $907
This means that $907 is the current equivalent of the sum of $1000 to be received after 2 years with a rate of return of 5% and it could be possible to reinvest this sum of $907 somewhere else to receive greater returns.
Explanation
The present value factor formula is centered on the idea of assessing if an ongoing investment can be encashed and utilized better to enhance the final outcome as compared to an original outcome that can be had with the current investment. With a view to estimating what would be the current value of a certain sum to be received on a future date, we need two factors, namely, the time interval after which the sum is to be received and the rate of return for the same. These two factors can then be used to calculate the present value factors for any given sum to be received on any given future date.
This PV factor would help calculate the current equivalent amount for the future sum in terms of time value for money and then it is used to calculate how better returns can be achieved by reinvesting this current equivalent in a relatively better avenue.
Use of Present Value Factor Formula
This concept of PV factor can be of great use in estimating if a current investment would be worth continuing with, or a portion of it can be received today and reinvested to receive greater returns. If one finds that the present value of the sum to be received in the future can yield higher returns in an alternative investment, it shed further light on the value of current investment and any viable alternatives. This would potentially be of great help in making better-informed investment decisions.
Present Value Factor Calculator
You can use the following present value factor calculator.
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Present Value Factor Formula in Excel (with excel template)
Let us now do the same example above in Excel. This is very simple. You need to provide the two inputs of Rate of Returns and Number of Periods.
You can easily calculate the Present Value Factor in the template provided.
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This has been a guide to Present Value Factor formula, its uses along with practical examples. Here we also provide you with a Present Value Calculator with a downloadable excel template.
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