What is the present value?
The present value refers to the current value of a future stream of income. By doing a present value calculation, we can compare the current value of varying payment streams; which can help us select the payment stream that is appropriate for our goals. Doing a present value calculation requires us to know the desired capitalization rate, along with the number of payment periods, the payment per period and the future value, if any. As an example, if we want to earn a return of five per cent, then we can use five percent as the capitalization rate to compare the value of different payment streams, as follows: Option #1 Option #2 Capitalization Rate: 5.0% 5.0% Monthly Payment Periods: 240 360 Payment per Period: $34.90 $18.50 Future Value: $0.00 $3,125.00 In looking at the data above, most of us would not be able to tell which payment stream has a higher present value. But, if we use the data above to do a present value calculation; then we receive the following results: Option #1 Option
