Use this present value calculator to compute the value today of a lump sum payment in the...show more instructions
What Is The Present Value Of A Future Lump Sum?
Are you expecting to receive a lump sum of money in the future?
What is the value of that money in today’s dollars? What is it worth to you today?
You must always think about future money in present value terms so that you avoid unrealistic optimism and can make apples-to-apples comparisons between investment alternatives.
This Present Value Calculator makes the math easy by converting any future lump sum into today’s dollars so that you have a realistic idea of the value received.
Below is more information about present value calculations so you understand the factors that affect your money and how to use this calculator properly.
Net Present Value
Net present value (NPV) is the value of your future money in today’s dollars. The concept is that a dollar today is not worth the same amount as a dollar tomorrow.
The purchasing power of your money decreases over time with inflation, and increases with deflation.
In addition, there is an implied interest value to the money over time that increases its value in the future and decreases (discounts) its value today relative to any future payment.
Since the value of money changes with time, all financial calculations must be brought to a constant date (usually today, thus the term “present” value) to make accurate comparisons between competing investment alternatives.
Net present value is considered a standard way of making these investment decisions.
Businesses use present value calculations for capital expenditures and routine business planning. Similarly, smart wealth builders run their finances like a business so they also use net present value for better family financial planning.
Net Present Value Illustration
Imagine someone owes you $10,000 and that person promises to pay you back after five years. If we calculate the present value of that future $10,000 with an inflation rate of 7% using the net present value calculator above, the result will be $7,129.86.
What that means is the discounted present value of a $10,000 lump sum payment in 5 years is roughly equal to $7,129.86 today at a discount rate of 7%.
In other words, you would view $7,129.86 today as being equal in value to $10,000 in 5 years, based on the same assumptions.
That’s because the impact to your net worth of $7,129.86 today is roughly equal to $10,000 in 5 years net of inflation and interest.
That is what this present value calculator is demonstrating.
Present Value Formula
It is important to understand that the three most important components of present value are time, expected rate of return, and the size of the future cash amount. All of this is shown below in the present value formula:
PV = FV/(1+r)n
PV = Present value, also known as present discounted value, is the value on a given date of a payment.
FV = This is the projected amount of money in the future
r = the periodic rate of return, interest or inflation rate, also known as the discounting rate.
n = number of years
When Is The Present Value Used?
The present value formula has a broad range of uses.
It is used both independently in a various areas of finance to discount future values for business analysis, but it is also used as a component of other financial formulas.
For example, present value is used extensively when planning for an early retirement because you’ll need to calculate future income and expenses.
Present value can also be used to give you a rough idea of the amount of money needed at the start of retirement to fund your spending needs. You’ll then compare that to what you have saved now – or what you think you’ll have saved by your retirement date – and that gives you a rough idea of whether your savings is on track or not.
To get a full picture of the amount you need to retire, see our Ultimate Retirement Calculator here and how it applies net present value analysis for your retirement planning needs.
Pros And Cons Of The Present Value Method
The net present value calculator is easy to use and the results can be easily customized to fit your needs. You can adjust the discount rate to reflect risks and other factors affecting the value of your investments.
Another advantage of the net present value method is its ability to compare investments. As long as the NPV of each investment alternative is calculated back to the same point in time, the investor can accurately compare the relative value in today’s terms of each investment.
However, there are few disadvantages of using the net present value method.
Always keep in mind that the results are not 100% accurate since it’s based on assumptions about the future. The calculation can only be as accurate as the input assumptions – specifically the discount rate and future payment amount.
Related: 5 Rookie Financial Planning Mistakes That Cost You Big-Time (and what to do instead!) Explained in 5 Free Video Lessons
Since the future can never be known there is always an element of uncertainty to the calculation despite the the scientific accuracy of the calculation itself.
Another problem with using the net present value method is that it does not fully account for opportunity cost. However, you can adjust the discount rate used in the calculator to compensate for any missed opportunity cost or other perceived risks.
The Present Value Calculator is an excellent tool to help you make investment decisions.
It discounts any future lump sum payment to today’s value so you can make apple-to-apples comparisons and make smart investment choice.
Simply knowing about future value and using it in your calculations will help you save money and make better investment decisions.
Present Value Calculator Terms & Definitions
- Future Value – The value of an asset at a specific date in the future.
- Inflation Rate – The rate at which the general level of prices for services and goods is rising, and, subsequently, purchasing power is falling.
- Compound Interval – How often inflation compounds.
- Present Value – The value today of a sum of money in the future, in contrast to some future value it will have when it has been invested at compound interest.
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