Click here to sign up for our newsletter to learn more about financial literacy, investing and important consumer financial news. If you keep all your payments, you will eventually receive $10,000. State and federal Structured Settlement Protection Acts require factoring companies to disclose important information to customers, including the discount rate, during the selling process. Calculating present value is part of determining how much your annuity is worth — and whether you are getting a fair deal when you sell your payments.
An investor can invest the $1,000 today and presumably earn a rate of return over the next five years. Present value takes into account any interest rate an investment might earn. Calculate the present value of this sum if the current market interest rate is 12% and the interest is compounded annually. Therefore, the present value of five $1,000 structured settlement payments is worth roughly $3,790.75 when a 10 percent discount rate is applied. Let’s assume you want to sell five years’ worth of payments, or $5,000, and the factoring company applies a 10 percent discount rate. Companies that purchase annuities use the present value formula — along with other variables — to calculate the worth of future payments in today’s dollars.
If you’re thinking about interviewing some prospective advisors, this new free tool will match you with highly-vetted local fiduciary investment advisors after a brief questionnaire. Please remember though, I do not give financial advice on this site. I will tell folks what calculator to use, and how to use a calculator. If you try it, scroll down the page and see tutorial #20 about PV calculations.
The lower an annuity’s rate of return is, the higher the annuity’s present value will be. It also addresses what a period is in terms of present value calculations and distinguishes between the formula for present value with simple interest and compound interest. Discounting is the procedure of finding what a future sum of money is worth today. As you know from the previous sections, to find the PV of a payment you need to know the future value , the number of time periods in question, and the interest rate. The interest rate, in this context, is more commonly called the discount rate. Sometimes the present value, the future value, and the interest rate for discounting are known, but the length of time before the future value occurs is unknown.
If the interest is simple interest, you plug the numbers into the simple interest formula. Once you know these three variables, you can plug them into the appropriate equation. If the problem doesn’t say otherwise, it’s safe to assume the interest compounds. If you happen to be using a program like Excel, the interest is compounded in the PV formula.
You simply divide the future value rather than multiplying the present value. This can be helpful in considering two varying present present value of a single amount and future amounts. The time value of money is an important concept not just for individuals, but also for making business decisions.