Present value: what a future sum is worth today
Present Value: The current worth of a future sum of money, given a specific rate of return. If you can earn 8% per year, $100 received one year from now is only worth $92.59 today — because $92.59 invested at 8% becomes exactly $100 in 12 months.
The formula for discounting a future amount to today
Present Value = Future Value ÷ (1 + r)ⁿ
The discount rate is your opportunity cost
The discount rate is your opportunity cost — the return you could earn on the best alternative investment. If you could reliably earn 10% per year, you discount future money at 10%. If you could only earn 3% in a savings account, future money is worth more to you today. Higher opportunity cost = lower present value of future promises.
How the discount rate changes present value
| Scenario | At 5% Discount Rate | At 10% Discount Rate |
|---|---|---|
| $10,000 in 5 years | $7,835 today | $6,209 today |
| $10,000 in 10 years | $6,139 today | $3,855 today |
| $10,000 in 20 years | $3,769 today | $1,486 today |
How analysts use present value to value a stock
This is exactly how stock analysts value companies. A company's stock price is the present value of all its future cash flows, discounted at a rate that reflects risk. When interest rates rise, all future cash flows are worth less today — which is why stocks tend to fall when rates rise sharply. The math of TVM connects your personal finance to every price on every market.
Explore how the discount rate changes an answer
Discounting a distant payment back to today
How time can outweigh the starting amount
Sit with the ideas.
A relative promises to give you $10,000 in 10 years. A bank offers you $6,500 today for that promissory note. Assuming you could invest at 8% annually, which is worth more — the $10,000 in 10 years or the $6,500 today?