Difference Between Present Value and Future Value

Present Value vs Future Value
 

Knowing the difference between present value and future value is very important for investors as present value and future value are two interdependent concepts that provide an utter help for the potential investors to make effective investment decisions; particularly for loans, mortgages, bonds, perpetuity, etc. By investing in an investment tool, the investors expect to obtain a stream of cash inflows. Similarly, there are some situations where the investors have to bear certain cash outflows as a result of their investment. Inflation is a fact which impacts the value of these cash flows. Present value is today’s value of future cash flows, discounted at a particular discount rate. On the other hand, future value is the value of the future sum of money at a specific future date. This is a nominal value.

What is Present Value?

Present value is the current worth of the future sum of money streams at a specific rate of return. This current worth can be found by discounting future cash flows at a pre-determined discount rate. This value assists investors to compare cash flows generating from investments at different time periods. Present value of a sum of money flow can be calculated using following formula.

Present Value    PV = FV (1 + i)-n  (or)

PV = FV × [1 ÷ (1 + i)n]

Where, PV = Present Value, FV = Future Value, i = Rate of Return, and n = Period of the Investment

What is Future Value?

Future value is the value of an asset or some of money at a specific future date. This is a nominal value, so does not include any adjustments for inflation, i.e. no any discount factors involved. This value basically estimates the total gain that can be obtained from an investment based on a given interest rate. Calculation of future value can be done using following two formulas.

For simple interest,          FV = PV (1+rt)

For compound interest, FV = (1+i)t

Where, PV = Present Value, FV = Future Value, i = Rate of Return, and t = Period of the Investment

Similarities between Present Value and Future Value

There exist some similarities between present value and future value. They are as follows.

  • Both are useful for appraising investment tools and interdependent, i.e. one determines by the other.
  • If the interest rate and the period remain constant, the present value and future value vary in a synchronized manner, i.e. if the future value increases, the present value also increases and vice versa.

What is the difference between Present Value and Future Value?

• Present value is the current value of future cash flow. Future value is the value of future cash flow after a specific future period.

• Present value is the value of an asset (investment) at the beginning of the period. Future value is the value of an asset (investment) at the end of the period that is being considered.

• Present value is the discounted value of future sums of money (Inflation is taken into consideration). Future value is the nominal value of future sums of money (Inflation is not taken into account).

• Present value involves both discount rate and interest rate. Future value involves interest rate only.

• Present value is more important for investors to decide upon whether to accept or reject a proposal. Future value shows only the future gains of an investment, so the importance for investment decision making is less.

Present Value vs Future Value Summary

Present value and future value are two important calculations for making investment decisions. Present value is the sum of money (future cash flows) today whereas future value is the value of an asset or future cash flows at a specified date. Both values are interconnected where one determines another. Present value takes inflation into consideration, so the money streams are discounted using an appropriate discount rate. However, in future value, it is mere nominal value adjusts only the rate of return to arrive at future gain of a particular investment.