Determining the present value of a given cash flow is based on the concept that money today is inherently worth more than the same nominal amount of money in the future; this is also known as the time value of money. The difference between cash flow delivered today relative to the same cash flow delivered at some point in the future is a function of time and the associated interest or discount rate.
To calculate present value using a financial calculator, obtaining the necessary data is the first step. Since calculating present value is the goal, the remaining variables must be determined to complete the calculation. Identifying a future value is a prerequisite element of calculating present value. It is impossible to determine present value without future value.
Next, the discount rate. or interest rate depending on the circumstances, is needed to calculate present value. The discount rate provides the requisite exchange rate due to the time value of money described previously.
After discount rate, incorporating the time span between the future value and present
value is necessary. Due to compounding rates. the longer the time span between the present period and future period, the larger the difference between present value and future value.
Finally, adjusting for any cash flows that occur in the interim periods between the present and future is necessary to determine an accurate value. If cash flows occur, they must be added or subtracted depending on the inflow or outflow.
For example, enter the future value in the calculator using the defined keystrokes. Next, enter the per period discount rate. For example, for quarterly compounding, use the annual rate divided by four; for monthly, divide by 12, etc. Proceed with the calculation by entering in the number of periods of time that elapses between the present period and future period in question. For example, for quarterly compounding for five years, the number of periods is 20m or five years times four quarters per year. If any cash flows occur, enter those in to the financial calculator module. Finally, using the defined keystrokes, calculate the present value.
Category: Personal Finance