How to Calculate Present Value of Future Cash Flows

If you understand the time value of money concept, you can also understand the theory behind the present value of future cash flows. Almost any loan is composed of making regular fixed payments back to the lender. This series of payments is determined by the interest rate you pay the lender, the time period and the amount of your initial payment or deposit. The present value of these payments is your loan amount.

Step 1

Review the calculation. The formula for finding the present value of future cash flows (PV) = C * [(1 - (1+i)^-n)/i], where C = the cash flow each period, i = the interest rate, and n = number of payments. This is the short cut to the long-hand version.

Step 2

Define your variables. Assume you want to find the present value of $100 paid at the end of the next 5 years, at an interest rate of 8 percent. C = $100, i = .08 and n = 5.

Step 3

Calculate the year one present value of a cash flows. Year one cash flows = C ($C) / (1+ i))^n. This equals $100/(1.08)^1 or $92.59. The present value of $100 in one year is $92.59 at 8 percent interest.

Step 4

Calculate the year two present value of a cash flows. This equals $100/(1.08)^2 or $85.73. The present value of $100 in two years is $85.73 at 8 percent interest.

Step 5

Calculate the year three present value of a cash flows. This equals $100/(1.08)^4 or $79.38. The present value of $100 in three years is $79.38 at 8 percent interest.

Step 6

Calculate the year four present value of a cash flows. This equals $100/(1.08)^5 or $73.50. The present value of $100 in four years is $73.50 at 8 percent interest.

Step 7

Calculate the year five present value of a cash flows. This equals $100/(1.08)^2 or $68.06. The present value of $100 in five years is $68.06 at 8 percent interest.

Step 8

Sum the PV for all 5 years. The PV of future cash flows is $399; that is, the present value of $100 paid at the end of the next five years at 8 percent interest is $399.

Step 9

Compare against the long-hand formula, (PV) = C * [(1 - (1+i)^-n)/i]. PV = 100 * [(1 - (1+.08)^-5)/.08] = $399. The present value of $100 paid at the end of the next five years is $399.

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