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Simple English definitions for legal terms
present value
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A quick definition of present value:
Present value is the amount of money you need today to have a certain amount of money in the future. It takes into account the interest you could earn on that money over time. For example, if you want to have $100 in one year and the interest rate is 5%, the present value would be $95.24. This is important for making financial decisions and evaluating investments.
A more thorough explanation:
Present value refers to the current value of a future sum of money, taking into account the time value of money and potential interest earned or inflation. It is the amount of money that would need to be invested today to reach a specific future value.
- If you want to have $10,000 in five years, and the interest rate is 5%, the present value of that amount would be $7,835.73. This means that if you invest $7,835.73 today at 5% interest, it will grow to $10,000 in five years.
- A company is considering investing in a new project that will cost $50,000 upfront but is expected to generate $70,000 in five years. The present value of this investment would be calculated by discounting the future cash flows by the cost of capital, resulting in a net present value of $16,386. This means that the investment is profitable and worth pursuing.
These examples illustrate how present value is used to determine the current worth of future cash flows. By calculating the present value, individuals and companies can make informed decisions about investments and financial planning.