What is Present Value?
Present value (PV) answers the question: what is a future payment worth today? The formula is PV = Future Value / (1 + rate)^years. At a 5% discount rate, $10,000 received in 5 years has a present value of $7,835. This means you should be indifferent between receiving $7,835 today and $10,000 in 5 years if you can earn 5% annually.
Net Present Value
Net present value (NPV) extends PV to evaluate investments with multiple cash flows. If an investment costs $100,000 today and generates $30,000 annually for 5 years, the NPV at a 10% discount rate is about $13,724. A positive NPV means the investment creates value; a negative NPV means it destroys value. NPV is the gold standard for capital budgeting decisions.
Key Considerations
The choice of discount rate is the most subjective and impactful element of PV calculations. A small change in the rate can dramatically alter the result. For retirement planning, using multiple discount rate scenarios (optimistic, moderate, conservative) provides a range of outcomes rather than a single potentially misleading number.