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Time Value of Money: FV and PV Explained

Chapter 5 introduces the concepts of Future Value (FV) and Present Value (PV) in the context of the Time Value of Money. FV represents the growth of an investment over time with compounding interest, while PV is the current worth of future cash flows discounted at a specific rate. The chapter explains the relationship between PV, FV, discount rates, and the basic equation used to calculate these values.

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33 views2 pages

Time Value of Money: FV and PV Explained

Chapter 5 introduces the concepts of Future Value (FV) and Present Value (PV) in the context of the Time Value of Money. FV represents the growth of an investment over time with compounding interest, while PV is the current worth of future cash flows discounted at a specific rate. The chapter explains the relationship between PV, FV, discount rates, and the basic equation used to calculate these values.

Uploaded by

hailey.halbert0119
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd

Chapter 5: Introduction to valuation: The Time Value of Money

Section 5.1: Future Value and Compounding

Future Value (FV) refers to the amount of money an investment will grow over some period
of time at some given interest rate.

Simplest case? A single-period investment.

Compounding interest is the process of leaving your money and any accumulated interest
in an investment for more than one period thereby “reinvesting” the interest.

Simple interest means the interest is not reinvested, so it is only earned each period on
the original principal amount.

(This Section explains how, and has a link to better explain, how to do FV and PV on
the calculator)

5.2 Present Value and Discounting

Present Value (PV) is the current value of future cash flows discounted at the appropriate
discount rate.

We “discount” the money instead of compounding it to the future, this is to calculate the
PV of some FV.

Discount Rate is the rate used to calculate the present value of cash flows.

The Discount Factor is used to discount future cash flow.

The discounted cash flow (DCF) valuation calculates the PV of a future cash flow to
determine its value today.

PV and discount rates are inversely related; increasing the discount rate decreases the PV
and vice versa.
5.3 More about Present and Future Values

(the ‘basic present value equation’)

There are four parts to the equation:

- The PV
- The FV
- The Discount Rate (r)
- Life of the investment (t)

Given any three of these we can always find the fourth.

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