How can we measure the Present Value
When we solve for present value, rather than compounding the cash flows to the future, we discount future cash flows to present value to match with investments which we are making today. Bringing the values to present serves two purposes:
1. Comparison between the projects become easier as the values of returns of both are as of today
2. We can compare earnings from the future with investment we are making today to get an idea of whether we are making any profit from investment or not.
For calculating the present value we need two things, one, discount rate (or opportunity cost of capital) and two, the formula.
Present value of a lump sum is just the reverse of the formula of compound value of the lump sum:
Present value = Future Value/ (1+i) n
Or to use the tables the change would be:
Present Value = Future Value * (Present Value Interest Factor n, i)
Where n = no of time periods and i is the interest rate.