Present Value

Present value is the current worth of cash to be received in the future with one or more
payments, which has been discounted at a market rate of interest. The present value of future
cash flows is always less than the same amount of future cash flows, since you can
immediately invest cash received now, thereby achieving a greater return than from a promise
to receive cash in the future. The concept of present value is critical in many financial
applications, such as the valuation of pension obligations, decisions to invest in fixed assets,
and whether to purchase one type of investment over another. In the latter case, present value
provides a common basis for comparing different types of investments.
An essential component of the present value calculation is the interest rate to use for
discounting purposes. While the market rate of interest is the most theoretically correct, it can
also be adjusted up or down to account for the perceived risk of the underlying cash flows.
For example, if cash flows were perceived to be highly problematic, a higher discount rate
might be justified, which would result in a smaller present value.
The concept of present value is especially important in hyperinflationary economies, where
the value of money is declining so rapidly that future cash flows have essentially no value at
all. The use of present value clarifies this effect.

Future Value
Future Value (FV) is a formula used in finance to calculate the value of a cash flow at a
later date than originally received. This idea that an amount today is worth a different
amount than at a future time is based on the time value of money.
The time value of money is the concept that an amount received earlier is worth more
than if the same amount is received at a later time. For example, if one was offered
$100 today or $100 five years from now, the idea is that it is better to receive this
amount today. The opportunity cost for not having this amount in an investment or
savings is quantified using the future value formula. If one wanted to determine what
amount they would like to receive one year from now in lieu of receiving $100 today,
the individual would use the future value formula. See example at the bottom of the
page.
The future value formula also looks at the effect of compounding. Earning .5% per
month is not the same as earning 6% per year, assuming that the monthly earnings are
reinvested. As the months continue along, the next month's earnings will make
additional monies on the earnings from the prior months. For example, if one earns
interest of $40 in month one, the next month will earn interest on the original balance
plus the $40 from the previous month. This is known as compound interest.

What is 'Simple Interest'

Simple interest is a quick method of calculating the interest charge on a loan. Simple interest
is determined by multiplying the daily interest rate by the principal by the number of days
that elapse between payments.
This type of interest usually applies to automobile loans or short-term loans, although
some mortgages use this calculation method.
Compound interest

The addition of interest to the principal sum of a loan or deposit is

called compounding. Compound interest is interest on interest. It is the result of reinvesting
interest, rather than paying it out, so that interest in the next period is then earned on the
principal sum plus previously-accumulated interest. Compound interest is standard in finance
and economics.
Compound interest may be contrasted with simple interest, where interest is not added to the
principal, so there is no compounding. Thesimple annual interest rate is the interest amount
per period, multiplied by the number of periods per year. The simple annual interest rate is
also known as the nominal interest rate (not to be confused withnominal as opposed to
real interest rates).

What is an 'Annuity'
An annuity is a contractual financial product sold by financial institutions that is designed to
accept and grow funds from an individual and then, upon annuitization, pay out a stream of
payments to the individual at a later point in time. The period of time when an annuity is
being funded and before payouts begin is referred to as the accumulation phase. Once
payments commence, the contract is in the annuitization phase.
Perpetuity

A perpetuity is an annuity that has no end, or a stream of cash payments that continues
forever. There are few actual perpetuities in existence (the United Kingdom (UK) government
has issued them in the past; these are known and still trade as consols). Real estate
and preferred stock are among some types of investments that effect the results of a
perpetuity, and prices can be established using techniques for valuing a perpetuity.
[1]
Perpetuities are but one of the time value of money methods for valuing financial assets.
Perpetuities are a form of ordinary annuities.
The concept is closely linked to terminal value and terminal growth rate in valuation.

Time value of money

The time value of money describes the greater benefit of receiving money now rather than
later. It is founded on time preference.
The principle of the time value of money explains why interest is paid or earned: Interest,
whether it is on a bank deposit or debt, compensates the depositor or lender for the time value
of money.
It also underlies investment. Investors are willing to forgo spending their money now if they
expect a favorable return on their investment.