The present value is often used in valuation to discount projections that companies make about themselves so they can figure out how much the company stock price is or maybe its equity value. The present value becomes useful because of inflation. If inflation were to increase at an increasing rate then the company would see the present day dollar as less valuable to them.
The present value formula is as follows:
PV = FV/((1 + i)n)
Jim Bob has just won the lottery. He has the choice of accepting the $2 million now, or he can accept $1 million now and another $2 million 5 years from now. Which of the choices should Jim Bob take? Assume a rate of 8%.
Option #1 PV = $2 million
Option #2 PV = $500,000 + $1,361,166 = 1,861,166
PV = 2 million/((1+.08)5) = $1,361,166
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