The time value of money
Money available now is worth more than the same amount later, for three reasons: you could invest it and earn a return, inflation erodes future purchasing power, and future payments carry the risk they never arrive. Present value (PV) quantifies all of this in one number using the formula PV = FV ÷ (1 + r)years, where r is the discount rate.
Choosing a discount rate
The discount rate is the return you could otherwise earn on your money — your opportunity cost. Use a low rate (3–4%) if your alternative is safe savings; a higher rate (8–10%+) if you'd otherwise invest in stocks or fund a business. The higher the rate, the more aggressively future money is discounted: at 10%, $50,000 in ten years is worth only about $19,300 today; at 3%, about $37,200. The rate choice dominates the answer.
Where present value decides real questions
- Lump sum vs installments: is a $500,000 lottery lump sum better than $700,000 paid over 20 years? PV settles it.
- Pension or buyout offers: comparing a one-time payout against a future stream.
- Business investment: a project's future cash flows are only worth their combined present value today — the basis of net present value (NPV) analysis.
The intuition to keep: whenever someone offers you money in the future, mentally discount it. Distant promises are worth less than their face value, and the longer the wait or the higher your opportunity cost, the bigger the discount.