Present value calculations involve the discounting of future cash amounts to a present value. The discounting means removing the interest, time value of money, or a targeted rate of return.
The rate used to discount the future cash amounts is referred to as the discount rate, effective interest rate, yield, yield-to-maturity, market interest rate, required rate, target rate, time value of money, time-adjusted rate of return, internal rate of return, and perhaps others.
To assist in calculating the present value of the future amounts, one can use mathematical formulas, the present value factors contained in present value tables, a financial calculator, or computer software.
The two most common present value tables are (1) the present value of 1 table, and (2) the present value of an ordinary annuity table. The present value of 1 table shows the present value of receiving a single payment of $1 sometime in the future. For example, if the time value of money is 10% per year, receiving $1 at the end of one year has a present value of 0.90909. The present value of receiving a single $1 at the end of two years is 0.82645.
Accountants may need to calculate the present value of some future amounts in order to comply with the cost principle.
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