Frequently asked questions
What discount rate should I use?
Use the rate of return you could earn on a similar-risk investment. For low-risk scenarios (government bonds), use 3–5%. For moderate risk (diversified portfolio), use 6–8%. For business decisions, use your company's cost of capital (often 8–12%). A higher discount rate means the future amount is worth less today.
How is present value different from inflation adjustment?
Present value discounts at your opportunity cost (what you could earn investing). Inflation adjustment uses the inflation rate (loss of purchasing power). They answer different questions: PV asks 'what should I pay today for this future amount?' while inflation adjustment asks 'what will this amount buy in the future?'
When would I use present value in real life?
Comparing a lump sum today vs a future payout (pension buyout, settlement offers), evaluating whether to pay now or later, pricing bonds, valuing rental income streams, or deciding between two investments that pay at different times. Any time you need to compare amounts that occur at different times.
Why does compounding frequency matter for present value?
More frequent compounding means you could earn more from investing the present value, so the present value is slightly lower. The difference is small for low rates or short periods. For most practical purposes, annual discounting gives a close-enough answer.
What is the relationship between present value and future value?
They are inverses. Present value asks: what is X in the future worth today? Future value asks: what will Y today be worth in the future? Both use the same compound interest formula, just solved for different variables. PV = FV / (1+r)^t, and FV = PV × (1+r)^t.