What is Present Value Factor (PV)
Present value factor is factor which is used to indicate the present value of cash to be received in future and is based on time value of money. This PV factor is a number which is always less than one and 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
This 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 moneyTime Value For MoneyThe Time Value of Money (TVM) principle states that money received in the present is of higher worth than money received in the future because money received now can be invested and used to generate cash flows to the enterprise in the future in the form of interest or from future investment appreciation and reinvestment., and then it is used to calculate how better returns can be achieved by reinvesting this current equivalent in a relatively better avenue.
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.
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 the 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 calculator.
|Present Value Formula =|| |
Present Value Factor 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 ReturnsRate Of ReturnsThe real rate of return is the actual annual rate of return after taking into consideration the factors that affect the rate like inflation. It is calculated by one plus nominal rate divided by one plus inflation rate minus one. The inflation rate can be taken from consumer price index or GDP deflator. and Number of Periods.
You can easily calculate this factor in the template provided.
This has been a guide to the Present Value Factor and its meaning. Here we calculate the PV factor along with its examples and uses. Here we also provide you with a Present Value Calculator with a downloadable excel template.
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