Question

Discuss what is PV (present value) and its relevance on a company’s FV (future value).

Answer 1

Present Value is the sum of future cash flows at a required rate of return which signifies how much you should have right now to reach a Future Value goal. Sometimes, the Present Value is what you have in today's currency and want to know how much would be its value in future at a rate of return.

Both Present Value and Future Value shows how time value of money impacts the number of dollars with time. The money that you have right now is more valuable than the same money in 5 years. Since there are various uncertainities around us, we cannot be sure that the cashflows or money that we are expecting in the future will be of same value as estimated today. To compensate for the risks and uncertainities, the Future Values are charged or discounted using a required rate of return which signifies the amount of risk these expected Future cashflows carry. Higher the risk in achieving the expected Future value, higher the required rate of return. Therefore, what we expect to achieve in 5 years, will always be less valuable right now.

In terms of a company, The Future Value is the cashflows expected in coming years based on company's performance, efficiency and opportunities. However, these estimated cashflows have risks attached to them in terms of Business risk and Financial risk. Therefore, the Future Value of the company is discounted or charged with a Discount rate which includes the risks associated with the cashflows. Once discounted, the Future Value of the company becomes the Present Value which signifies the current estimated value of the company. However, the Present Value of the company is strictly subjected to change in discount rate which may vary as uncertainities grow or decrease around company's business and finances.