The time value of money is the central part of investment and financing calculations. Following the compounding of money, one dollar today is more worth than one dollar in one year. To make one dollar today equivalent to one dollar in one year, it has to compounded with the interest rate for one year. Vice versa to make one dollar in year equivalent to one dollar today, it has to be discounted with interest rate for one year.

Present value

The present value (PV) is the current worth of a future sum of money or stream of cash flows (CF). To get the present value of future cash flows, the future cash flows are discounted by the interest rate (i). The higher the interest or discount rate, the lower the present value of the future cash flows.

Discounting with constant interest rate(i)

PV(t)= CF(1)/ [1+ i]^1 + ... + CF(t)/ [1+ i]^t + ... + CF(T)/ [1+ i]^T

Discounting with time dependend interest rate (i)

PV(t)= CF(1)/ [1+ i(1)]^1 + ... + CF(t)/ [1+ i(t)]^t + ... + CF(T)/ [1+ i(T)]^T

Where

PV: Present Value

t: current time periode

T: Last time period

CF: Cash flow

i: interest rate

Further see:

Wikipedia Time Value of Money