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Present Value
So $1,000 now is the same as $1,100 next year (at 10% interest).
The Present Value of $1,100 next year is $1,000
Present Value has a detailed explanation, but let's skip straight to the formula:
PV = FV / (1+r)n
PV is Present Value
FV is Future Value
r is the interest rate (as a decimal, so 0.10, not 10%)
n is the number of years
And let's use the formula:
PV
PV
PV
PV
=
=
=
=
FV / (1+r)n
$900 / (1 + 0.10)3
$900 / 1.103
$676.18 (to nearest cent)
PV
PV
PV
PV
=
=
=
=
FV / (1+r)n
$900 / (1 + 0.06 )3
$900 / 1.06 3
$755.66 (to nearest cent)
Like this:
Example: You invest $500 now, and get back $570 next year. Use
an Interest Rate of 10% to work out the NPV.
Money Out: $500 now
Example: Same investment, but work out the NPV using an Interest
Rate of 15%
Money Out: $500 now
Now: PV = -$2,000
Now: PV = -$2,000
Now: PV = -$2,000
That is good enough! Let us stop there and say the Internal Rate of Return is
12.4%
In a way it is saying "this investment could earn 12.4%" (assuming it all goes
according to plan!).
Or maybe one has high costs at the start, and another has many small
costs over time.
Example: instead of investing $2,000 like above, you could also invest 3 yearly
sums of $1,000 to gain $4,000 in the 4th year ... should you do that
instead?
I did this one in a spreadsheet, and found that 10% was pretty close: