Such a concept as discounted value exists not only to solve student economic problems, but also to conduct real business activities. It helps to evaluate the return on investment, payback periods of investments or projects. Each company leader needs to clearly understand the cash flow, their value and the impact of inflation, default and other economic metamorphoses.
Definition
The present value is the funds that are needed today to receive the indicated amount in the future under the given conditions. In order to better understand this, we can give an example. Suppose that in five years the company wants to receive an amount of $ 100,000 from its investments. Terms of deposit mean capitalization of funds at 10% profit. Thus, the discounted value of the required amount today will be about $ 18,200. This means that it is now necessary to invest $ 18,200 in this project in order to receive $ 100,000 in 5 years.
Formula
The present discounted value is determined by the following formula:
PV = FV / (1 + i) t ,
where PV is the present value;
FV - the amount that investors expect to receive;
i - interest rate of investments;
t is the duration of the investment.
The formula is very simple, and if necessary, you can find out the amount that the company will receive in the future with the available funds:
FV = PV * (1 + i) t
Application
You can use this knowledge not only to determine the necessary amounts, but also to calculate expected profits. For this, the net present value is used, which shows the amount of income minus invested funds. Using this indicator, you can find out the payback period of the project. This is especially true for large amounts, because it is always important to know how quickly this amount will begin to generate income. The discounted value helps to analyze the return on investment, as well as select projects where investments pay off faster in the allotted time period.
The present value can also help recount receivables and payables. It is known that inflation leads to the depreciation of money, and thus, when the payment is delayed, the
purchasing power of the debt amount decreases. This should be taken into account when settling with suppliers and banks. For this reason, many companies prefer to conclude long-term contracts on a
deferred payment basis
. This approach allows them to buy raw materials and products "at old prices." If these transactions are carried out in large amounts, then the savings are simply colossal.
It is also worth considering this when carrying out activities as a supplier or distributor. When concluding contracts, it is necessary to provide for inflation and impose additional interest on the amount when the payment is delayed. A balanced economic approach will help any company to anticipate possible complications in the calculations, as well as invest their funds in the most profitable way.