The
present value of money means the exact amount that one can get from his investment at present. If someone is receiving $5,000 at present, then it means that the present value of that money is $5,000. At the same time, if someone is assured to have $5,000 after two years, the present value of that money is obviously not the same. The money which someone is going to receive in the future is actually the total future value of the money and the exact amount of money, that should be invested today to get that particular amount in the future, is the present value of the money.
Present value of money and future value of money jointly forms the time value of money. According to these theories, time and money are related to each other and the exact value of money in the present is different from the value of the same in the future. So that it is very important to understand the different values of money in order to get the best returns in future, from the investments of present.
To bring out the present value, one should subtract the total interest from the total amount that is expected to be received in the future. For the purpose, one may reduce the payment amount of future by the interest rate fixed for the entire period. So, in terms of equation we can say that:
PV = FV* (1 + i)-n
According to this equation, if the rate of interest is 4.5% for the entire term, the present value of the money would be somewhere near $4,382.
The
present value of money is mainly used for the business purpose. It is also used in the economical calculations and data preparation. This is mainly used for comparing the availability of cash at various times. Compound interest is a well known example of the time value of the money.