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- What Is Present Value and How Do You Use the Present Value Formula?
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## What Is Present Value and How Do You Use the Present Value Formula?

If you already understand the concept of future value, you can learn the next concept of present value. What is the “present value” of $100 today? It’s also $100! Why? Because “present” means “today.”

Let’s say you have $100 in the bank today. However, this money in the bank has already been earning interest for 1 year. Let’s say (for example) that 1 year ago that money was only a little more than $95 (let’s just use $95 for simplicity) and then it earned interest over the year and so it’s now worth $100. What is the “past value” of your $100? Simple again! It’s $95.

However, this was just a very simple example to demonstrate the concept. The main challenge in business school or real business is figuring out exact numbers using scary-looking but very simple formulas.

The present value (aka PV) or past value formula looks simplified like this:

PV = (1 + interest rate)^n

Where n = number of years.

Don’t be afraid. Depending on your learning style, the best way to learn how to use formulas and calculate may not be from a book or written words. You may prefer to watch it on video on one of the many free online tutorial websites or on YouTube. Additionally, many modern scientific calculators and iPhone and Android apps allow users to calculate the exact same results instantly and without hassle.

The most confusing thing about the concepts of present value and past value is that many business schools, as well as many books, explain both as if they were the same thing. However, they are not the same. They are very different! Why the confusion? Because they use a common formula. However, the result of the formula will tell you one of them, depending on how the story is told.

To illustrate:

1) In an example, let’s say you have $100 today. How much was it last year before it earned 5% interest? Use the standard formula and you get a past value of just over $95.

2) In another separate example, let’s say you have $105 next year after earning 5% interest for 1 year. How much is it worth today? Using the same formula above, you get a present value of $100.

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