Present Value of One

Definition§

The Present Value of One (PV1) is the current value of a future sum of money, given a specific interest rate. This concept relies on the principle of compound interest, allowing one to estimate what a future amount of money is worth in today’s dollars. The formula to calculate PV1 is:

$$PV1 = \frac{1}{(1 + i)^n}$$

Where:

• $i$ = Interest rate per period
• $n$ = Number of periods

By using this formula, investors and analysts can assess the current worth of sums to be received in the future, crucial for making informed financial decisions.

Examples§

1. Example 1:

   • Interest Rate: $15$
   • Period: $1$ Year
   • Future Amount: \( $1 \)
   • $PV1 = \frac{1}{(1 + 0.15)^1} = 0.869565$
   • Present Value = $0.869565

2. Example 2:

   • Interest Rate: $15$
   • Period: $2$ Years
   • Future Amount: \( $1 \)
   • $PV1 = \frac{1}{(1 + 0.15)^2} = 0.756144$
   • Present Value = $0.756144

Frequently Asked Questions (FAQs)§

Q1: What is the present value factor?
A1: The present value factor is a multiplier used in calculating the present value of a future cash flow. It is defined as $\frac{1}{(1 + i)^n}$ where $i$ is the interest rate and $n$ is the number of periods.

Q2: Why is the Present Value of One important in real estate?
A2: PV1 is vital for determining the value of rental income, lease payments, and other future cash flows in today’s terms. It helps investors make decisions based on the current value of future incomes.

Q3: How do interest rates affect the Present Value of One?
A3: Higher interest rates decrease the PV1, while lower interest rates increase it. This is because the future amount is discounted more heavily as the interest rate rises.

Q4: What’s the difference between Present Value and Future Value?
A4: Present Value determines the current worth of a future sum of money, while Future Value calculates how much a current sum of money will be worth in the future, given a specific rate of return.

Related Terms§

• Future Value (FV): The value of a current asset at a future date, based on an assumed rate of growth.

• Discount Rate: The interest rate used to discount future cash flows to their present value.

• Compound Interest: Interest calculated on the initial principal and also on the accumulated interest of previous periods.

• Time Value of Money (TVM): A finance principle that suggests money available now is worth more than the same amount in the future due to potential earning capacity.

Online Resources§

1. Investopedia’s Time Value of Money - Comprehensive resource on the time value of money principles.
2. Khan Academy’s Finance and Capital Markets - Video explanations and tutorials.
3. Bankrate’s Present Value Calculator - Quick calculator for determining present values.

References§

• Gitman, L. J., & Zutter, C. J. (2012). Principles of Managerial Finance. Pearson Education.
• Brueggeman, W. B., & Fisher, J. D. (2011). Real Estate Finance and Investments. McGraw-Hill Irwin.

Suggested Books for Further Studies§

1. “The Real Estate Investor’s Guide: Financial Calculations and Pro Formas” by David M. Simpson.
2. “Time Value of Money: Theory, Practice, and Management Implications” by Stephen A. Ross, Randolph W. Westerfield, Jeffrey F. Jaffe.
3. “The Time Value of Money in Real Estate Investing: Concept, Application & Impact” by Chris Parker.

Real Estate Basics: Present Value of One Fundamentals Quiz§