Present Value

Present value is what money due in the future is worth today. You take the future amount and discount it back to the present using a discount rate.

The arithmetic is simple. At a 5% discount rate, 1,050 due in a year has a present value of 1,000. The same 1,050 due in two years is worth less again — the further out, the smaller the present value.

Everything turns on the discount rate you choose. It approximates the return you could have earned using the money elsewhere, and a higher rate shrinks future money sharply.

This is why growth stocks swing hard when rates rise. Most of their value sits in profits far in the future, and a higher discount rate makes those distant profits much smaller in today's terms.

The calculation also settles the lump-sum-versus-instalments question for pensions and settlements. Instalments can total more yet still lose to the lump sum once discounted to present value.