Question

How do you or other people use the present-value formula to make decisions?

Answer 1

Present Value is the Total Equivalent Value of All Future Values as on TODAY.

Whenever, there are different alternative, with different time durations or number of payments and/or different cash flows at different time durations, Net Present Value should be calculated to compare which alternative is Better.

For Exapmle,

Alternative 1: CF at Year 1 = 5000, CF at Year 2 = 10000, CF at Year 3 = 8000

Alternative 2: CF at Year 1 = 4000, CF at Year 2 = 8000, CF at Year 3 = 11000

Interest Rate = 10%

Total of All 3 years Cash Flows for both Alternative is 23000, But they are occuring at different times.

Year	Cash Flow	Discountig Factor [1/(1.1^period)]	PV of cash flows (cash flow*discounting factor)
1	5000	0.909090909	4545.454545
2	10000	0.826446281	8264.46281
3	8000	0.751314801	6010.518407
		NPV of Alternative 1= Sum of PVs	18820.43576

Year	Cash Flow	Discountig Factor [1/(1.1^period)]	PV of cash flows (cash flow*discounting factor)
1	4000	0.909090909	3636.363636
2	8000	0.826446281	6611.570248
3	11000	0.751314801	8264.46281
		NPV of Alternative 2= Sum of PVs	18512.39669

From above, it can be said that, Net Present Value of Alternative 2 is Lower compared to Alternative 1. Therefore, Decision can be taken accordingly.