How to Calculate Present Value

A Step-by-Step Tutorial
Tutorial 20

Present value is a critical financial concept.

Investors calculate the present value (PV) of the remaining scheduled payments when purchasing a mortgage or loan. To settle disputes, attorneys make present value calculations when determining the value of an anticipated future cash flow. wikinvest defines present value as "'s value of a set of cash flows that will occur in the future. It is calculated by dividing future cash flows by an appropriate discount rate." The Ultimate Financial Calculator is designed to calculate present value under any scenario, for any cash flow.

All users should work through the more detailed first tutorial to understand the Ultimate Financial Calculator's (UFC) basic concepts and settings.

For this tutorial, let's assume you are a lottery winner. The lottery commission has offered you the choice of receiving $35,045.00 paid monthly for the next twenty years OR a single, lump sum payment of $5,476,123.50. Which option should you select?

To calculate the present value, follow these steps:

  1. Set "Schedule Type" to "Savings"
    • Or click the [New] button to clear any previous entries.
  2. Set "Rounding" to "Open balance — no adjustment" by clicking on {Settings} {Rounding Options}
  3. In the header section, make the following settings:
    1. For "Calculate Method" select "Normal"
    2. Set "Initial Compounding" to "Exact/Simple"
    3. Enter 5.5 for the "Initial Interest Rate"
      • This is the annual rate of return you assume you can earn your investments
      • It is also known as your "discount rate"
  1. In row one of the cash flow input area, create a "Withdrawal" series
    1. Set the "Date" to "October 3, 2024"
    2. Set the "Amount" to "Unknown". Fig. 1
    3. Set the "# Periods" to 1
      • Note: Since the number of periods is 1, you will not be able to set a frequency. If a frequency is set, it will be cleared when you leave the row
  1. Create the anticipated series of lottery payments in the second row
    1. Select "Deposit"
    2. Enter the "Date" as "November 1, 2024"
      • Expected date the first payment is due from the lottery commission)
    3. Enter the "Amount" as $35,045.00 (periodic winnings)
    4. Enter 240 for "# Periods"
    5. Select "Monthly" for "Frequency". The calculated "End Date" will be October 1, 2044. (The last payment date.)
Initial present value calculation screen
Fig. 1 - Present value calculation set up.
  1. Click the [Calculate] button
    • The result is "$5,063,030.40". Fig. 2
Present value calculation result
Fig. 2 - Result of present value calculation.
    • Assuming a future cash flow of 240 monthly deposits of $35,045.00 each, the present value is $5,063,030.40. This is less than the lottery is offering ($5,476,123.50) as a single payment amount. Therefore, it seems reasonable to accept the single payment from the lottery since it has a greater value than the PV of the future deposits.

Note 1: The cash flow stream may be comprised of a single amount or a series of deposits, withdrawals or payments and there may be as many different cash flow streams (different date schedule or different amounts) as needed. When calculating the present value, the amount for the first entry is always "Unknown", the date is set to the current date and the series is set to the opposite selection of the future cash flow stream.

Note 2: This example is NOT considering tax consequences. As we all know, tax implications can be significant. You should seek the guidance of a tax professional if you were making this decision.

Note 3: This example also does not consider risk. If you accept a single sum settlement option a present value calculation indicates, will you be able to invest the money to equal the future value of the cash flow? On the other hand, if you accept the series of future payments, what's the risk of the provider of the cash flow not being able to meet their obligation? In the case where the cash flow is in doubt, it might be better to take a single lump sum even if it is worth less than the future cash flow.