What Is Present Value Table?
Definition: A present value table is a chart used to calculate the current value of a stream of money to be received in the future. The table multiplies coefficients by the future cash flows to calculate the present value of the cash flow stream.
Present value measures the current value in today’s dollars of a future sum of money based on a predetermined rate of interest. While future cash are discounted at a higher discount rate, as the rate increases, the present value decreases. Thus, they are inversely correlated.
Therefore, in the present value table, the discount rate or the coefficient is the most important factor for valuing cash flows in the the future. The discount rate is the interest rate or return used to equate future money to its current value. In its purest form, it is the expected return that investors get on investing the current amount for money for some time.
The present value table, therefore, seeks to show the value of money expected in the future. The use of coefficients many at times ends up showing that money received in the future may not be equal to the amount received today due to forces of inflation, among other factors.
Present Value Table Example
The table comes with multiple rows and columns. The column section on the left is used to indicate weeks, months as well years upon which future cash flow is expected. The row at the top shows the discount rate.
Consider the present value table above. Let’s assume you will get a payment of $5,000 in four years at a discount rate of 8%. Thus, you’ll use 0.7350 as the coefficient to compute the present value of the $5,000.
This is shown at the intersection of n=4 and 8% discount rate. In this case, you will have to multiply $5,000 with 0.7350, which amounts to $3,675.
What this means is that the $5,000 expected in future would be worth $3,675 now.
Now assume company XYZ wants to sell $2,000 assets. However, the buyer intends to pay $2,200 for the assets, but at a future date. When it comes to making a decision on whether to accept the offer, company XYZ might use the present value table.
Consequently, consider a discount rate of 4% with a coefficient of 0.9615. Multiplying the proposed buy price of $2,200 with 0.9615, it is clear that the $2,200 value would be worth $2,115 now. Likewise, company XYZ can go forth and sell the asset as it would still be able to receive a profit above the $2,000 it intended to sell.
Understanding Present Value Table
The table, in its purest form, provides present value coefficients for different sums of money at different periods as well as discount rates. While periods may appear in year, months or even weeks, discounts appear in .25% intervals from 0% – 20%.
When properly used, the present value table can be used instead of a financial calculator for most present value amounts. However, the table may not be as accurate as using an actual equation.
The rounding off of coefficients to fourth decimal places tends to trigger errors in some computations. Likewise, most tables only have a few interest rates and time periods. However, the present value table method of calculating PV of future values is still popular in both college textbooks and classrooms. In the real world, we use calculators. 🙂
Summary
The present value table is used to measure the current value of future money without using an equation or a calculator. While a reliable option, a financial calculator is more accurate because of the effects of rounding. Tables can be used to compute inflation, but you must figure that into your discount rate. Likewise, the rounding off of coefficients also triggers errors. Overall, it’s a great shorthand tool to use if you don’t have a calculator.