“A bird in the hand is worth two in
the bush.” While this phrase was first used in mediaeval times,
the person who said it must have had some idea about present value. In a sense, present value
answers the question about how money in the future is worth today.
Most people understand intuitively that $10 today is more valuable
than $10 a year from now. Furthermore, if you have the option of $10
today, $11 a year from now, or $15 three years from now, which one
would be the best option? This article will show you how to make
that decision.

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**Comparing apples to apples**

The problem is that the amounts of
money really can’t be compared. To change the example, suppose you
had the option of receiving $10, 50 yen, or 50 rupees. Which would
you choose? You would not look at the raw numbers, because they’re
for different currencies. First, get them into a common currency,
and then see which one is the largest amount. In this case, 50 yen
is less than $1, and 50 rupees is about $1. Choosing $10 would make
the most sense.

It is the same problem in choosing
among the different options in our earlier example. Present Value
(PV) is the term that is used to take money paid at different times
and converting them to a common basis for comparison in today's
dollars, similar to the currency example.

##
**Discount rate**

The place to begin the conversion
process is with figuring out the discount rate. The discount rate is the
interest rate that you would expect for an investment. It is
important to determine a good value for the discount rate, as it
becomes the basis for converting the future cash payments to a value
today. Selecting the discount rate can be done in several ways. For
example, a business may use a discount rate that is the minimum
return they would expect from any investment. Individuals might
choose a discount rate that reflects their desired investment return.
In either case, selecting a discount rate that is either too high or
too low will improperly skew the results, so choose carefully.

##
**Determining present value**

Let’s choose 10 percent as the discount rate
for answering the question which of the three options in the earlier
example is the best. The baseline is $10, since that is the amount
available today. For the future values for this example, the rate is
only applied once per year, so $11 one year now can be discounted by
dividing the future amount by 1 plus the discount rate. In this
situation, the present value equals $11/(1 + .1) or $10. So, $11 one
year from now is equal to $10 today at a 10 percent discount rate.

What about $15 three years from now?
The present value calculation would be similar,
except the above formula would have to be applied three times, once
for each period. Since this can become very tedious, most financial calculators and spreadsheet software packages have this calculation
built in. Using this formula, $15 three years from now is worth
$11.28 today.

##
**Putting it all together**

Using this approach, it’s clear which
option to choose. The third option, $15 three years from now would
be the best option. You can use this approach to evaluate any kind
of investment where payments occur at different times.

**About the author**: This article was written by Donald Turner, an avid finance writer online, on behalf of Approved Cash Advance. If you're looking for an InheritedCash Advance, make sure to check out their website and see what they can do for you.

Image license: FamZoo Staff, CC BY-SA 2.0