Present Value Analysis

• Today’s value of money expected from future income.

• Calculated as sum of future investment returns discounted at a specific rate of return expectation.

Formula:
PV = FV / (1 + r)n
FV = Future Value
i = Discount rate
n = Investment periods
Applications
Investment Analysis
Used by investors to evaluate the potential return on an investment.
Example: An investor may want to know the present value of an investment that is expected to generate $10,000 in
five years. If the investor's required rate of return is 5%, the present value:
PV = 10000 / (1 + 0.05)5 = $ 7,835.26

Project Evaluation
Used by companies to evaluate the cost and benefits of different projects and determine the if it will give higher
returns.
Example: A company may be considering a project that will cost $100,000 to implement and is expected to generate
$30,000 in cash flows per year for the next five years. Rate of return = 10%.
PV = ($30,000 / (1 + 0.10)) + ($30,000 / (1 + 0.10)2) + ($30,000 / (1 + 0.10)3) + ($30,000 / (1 + 0.10)4) + ($30,000 / (1 +
0.10)5) = $106,689.96
Applications Contd.
Capital Budgeting
Used by investors to evaluate and select long-term investments that can generate cash
flows over the years. Used to compare different investments.
Example: A company may be considering two different investments. Investment A is
expected to generate $50,000 in cash flows over the next five years, while Investment B is
expected to generate $70,000 in cash flows over the next ten years.
Investment A: PV(A) = $50,000 / (1 + 0.08)^5 = $31,853.80
Investment B: PV(B) = $70,000 / (1 + 0.08)^10 = $38,965.53
Limitations

• Dependency on future estimate of cash flows. Difficult to predict.

• Very prone to inaccuracy under changing market conditions, unexpected expenses and other
factors.
• A constant discount rate over time.

Conclusion
Present value analysis is a valuable tool for assessing the current value of future cash flows. It assists
in making informed financial decisions, considering the time value of money.