Amount today is worth more than amount tomorrow. In many cases it becomes important to know the present value of accumulated return of an investment. This gives a clear idea to the investors about the worth of an investment. Present values can be calculated by using the formula given below.
PV= FV / (1+r)
Present Value = PV
Future Value = FV
Discount rate = r
Example: Suppose George needs 4000 next year to purchase a new laptop. Interest rate is 7% per year. How much amount George should keep aside now in order to purchase Laptop; calculate present value of 4000 at 7% interest rate.
PV = 4000 / (1.07) = 3738.32
Note: George should invest 3738.32 for a year to purchase a laptop. If George has longer time to purchase a laptop he needs to investment less today. For example if George purchases laptop after two years, calculate present value by dividing future payment by (1.07)^2
PV= 4000 / (1.07)^2 = 3493.75
This time George just need 3493.75 today to pay 4000 after two years, It means that the level of investment will increase or decrease with the number of years.
How to Find Interest Rate
For example: when George want to purchase a laptop at 4000 after one year and today he has to invest amount of 3738.38, but he does not know about interest rate. So he simply calculates interest rate: