Key point
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.
Formula
Present Value = Future Value ÷ (1 + r)ⁿ
Key point
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.
Compare
| 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 |
Key point
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.
Try it
Check-in
Check-in
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?