In its simplest form, calculating the present value of a single cash flow involves dividing the amount of the future value of the single cash flow by the following interest factor:
$ \left(1 + i \right) ^ t $
Where t refers to the number of years for which the investment is made and i refers to an annual interest rate in this formula format.
If we were to calculate the present value of a 100 unit cash flow in one year or a 200 unit cash flow expected in two year’s time respectively and discounting at an annual interest rate of 5%, the calcs will look as follows:
Present value of the 100 FV expected in one year:
$PV = FV \div \left( 1+ i \right) ^t = 100 \div \left( 1+ 5\% \right) ^ 1 = 100 \div \left( 1.05 \right) = 95.2381$
After two years:
$FV = PV \div \left( 1+ i \right) ^t = 200 \div \left( 1+ 5\% \right) ^ 2 = 200 \times \left( 1.1025 \right) = 90.7029$
Due to the annualised assumptions we make above, this particular formula isn’t of much use to us during the other 364 days of the year.
To expand your understanding, you may choose to jump to any of the following pages:
PV of a single cash flow
Nominal Interest Rates
NACC, NACS, NACQ and NACM