Present factor allows an easy calculation to determine how much money received at a future date is worth now. For example, a person will receive £6,500 in five years and the person wants to know how much the £6,500 is currently worth. Currently, the £6,500 will be worth less than £6,500 due to the time value of money. Time value of money is that money now is worth more than money in the future.
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Add 1 to the interest rate. For example, if there is an interest rate of 5 per cent due in six years then, 1 + 0.05, which equals 1.05.
Raise the answer in Step 1 to the power of the amount of time. In the example, the amount of time is six years, therefore the equation is 1.05 ^ 6 which equals 1.3401.
Divide 1 by the number calculated in Step 2. In the example, 1 / 1.3401 equals 0.7462.
Tips and warnings
- It is easier to use a present value table than to do the actual mathematical formula.
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