If you are planning to buy or sell an asset you must know the present value of the asset. It is very easy to know the value if the asset earns cash only once now. But it becomes more complex for assets which keep earning money over a period of time. In that case it is more important to compute the present value of the asset. In this article we will discuss with example how to calculate the present value of an financial asset.

Present Value of a Financial Asset

We discussed basic concepts like cash flow, present value, future value and discount rate in the last article. If you have not read it yet we suggest you read it before you continue with this article. You can read it here:

How to calculate the right price to buy or sell an financial asset?

Calculation of Present Value

Simple Formula to Calculate Present Value

Now that we know the basic concepts let us proceed to actual calculation of present value. As discussed in the last article Present Value of an asset is defined as the discounted value of all future cash flows generated from that asset. So, basically we need to know two things to calculate present value. One is future cash flows and the other is the appropriate discount rate. Assuming that we know the future cash flows from that asset and discount rate we compute present value using the following formula: Present Value of PV = C1/(1+r). Here we assumed that C1 is the single cash flow generated from the asset one year from now and r is the discount rate.

Present Value Calculation Example

So, for example you are planning to buy a stock of a company. You know you can sell the stock for $100 one year from today. And the discount rate is 4%. Then the present value of the stock is = 100/(1+.04) = 100/1.04 = $96.15. Note that here we have assumed a very simple case to get the concept clear. In the future articles we will see how to calculate the present value for more complex cases which will resemble the reality more closely.