Question

1. What is the relation between the present value factor and the future value factor?

Answer 1

The present value (PV) factor gives the present value of receipt of cash on a future date. The concept of PV factor is based on time value of money. Here, money received now is worth more than money received in the future, since money received now can be reinvested in an alternative investment to earn additional cash. The PV factor is greater for cash receipts scheduled for the near future. It is smaller for receipts that are expected on later date. The factor is always a number less than one. The formula for calculating the present value factor is:

P = {1 / (1 + r)^n}

Where:

P = Present value factor

r = Interest rate

n = Number of periods

Future Value (FV) Factor, is a component that helps to calculate the future value of cash flows that will be paid at a future date. The future cash flow could be a single cash flow or a series of cash flows over the period. This factor helps us to determine the effect of compounding of a single cash flow or multiple cash flows, that occur at regular time intervals, in the future. This is based on the time value of money concept.

FVF = (1 + r)^n

Where:

r = interest rate

n = number of periods

So, basically the relation between PV Factor and FV Factor is, they both are based on the time value of money. In PV factor, we calculate the present value of future cash flows and in FV factor we calculate future value of cash flows.