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Present Worth

Present Worth (PW), or Present Value (PV), is a financial concept used to assess the current value of future cash flows discounted at a specific rate. The calculation involves identifying cash flows, determining a discount rate, applying the present worth formula, and summing the present values. It is widely used in investment decisions, loan analysis, project evaluation, and has advantages like accounting for the time value of money, though it also has limitations such as sensitivity to discount rate changes.

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13 views3 pages

Present Worth

Present Worth (PW), or Present Value (PV), is a financial concept used to assess the current value of future cash flows discounted at a specific rate. The calculation involves identifying cash flows, determining a discount rate, applying the present worth formula, and summing the present values. It is widely used in investment decisions, loan analysis, project evaluation, and has advantages like accounting for the time value of money, though it also has limitations such as sensitivity to discount rate changes.

Uploaded by

Ammar Ahmed
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Present Worth (PW), also known as Present Value (PV), is a financial

concept used to determine the current value of a future sum of money or a


series of cash flows, discounted at a specific rate of return (discount rate). It
is a fundamental concept in finance, economics, and engineering economics,
helping to compare the value of money over time.

Key Formula for Present Worth:

The general formula for calculating the present worth of a single future cash
flow is:

PW=F(1+i)nPW=(1+i)nF
Where:

 PWPW = Present Worth (or Present Value)


 FF = Future amount of money
 ii = Discount rate (interest rate) per period
 nn = Number of periods (years, months, etc.)
For a series of cash flows (e.g., annuities), the present worth formula is:

PW=∑t=1nCt(1+i)tPW=t=1∑n(1+i)tCt
Where:

 CtCt = Cash flow at time tt


 tt = Time period
 nn = Total number of periods

Steps to Calculate Present Worth:

1. Identify Cash Flows:


o Determine the future cash flows (single amount or series of
payments).
2. Determine the Discount Rate:
o Choose an appropriate discount rate (e.g., interest rate, cost of
capital).
3. Apply the Present Worth Formula:
oDiscount each future cash flow to its present value.
4. Sum the Present Values:
o Add up all discounted cash flows to get the total present worth.

Example of Present Worth Calculation:

Suppose you expect to receive $10,000 five years from now, and the
discount rate is 5% per year. The present worth is calculated as:

PW=10,000(1+0.05)5=10,0001.2763=7,835.26PW=(1+0.05)510,000
=1.276310,000=7,835.26
So, the present worth
of 10,000receivedfiveyearsfromnowis∗∗10,000receivedfiveyearsfromno
wis∗∗7,835.26**.

Applications of Present Worth:

1. Investment Decisions:
o Compare the present worth of future cash flows to the initial
investment cost.
2. Loan Analysis:
o Determine the present value of loan payments to assess
affordability.
3. Project Evaluation:
o Evaluate the profitability of projects by comparing present worth
of costs and benefits.
4. Lease vs. Buy Decisions:
o Compare the present worth of leasing versus buying an asset.

Advantages of Present Worth:

 Accounts for the time value of money (money today is worth more
than the same amount in the future).
 Provides a clear metric for comparing alternatives.
 Useful for long-term financial planning.
Limitations of Present Worth:

 Requires accurate estimation of future cash flows and discount rates.


 Sensitive to changes in the discount rate.
 Does not account for non-monetary factors (e.g., risk, qualitative
benefits).

Present Worth in Engineering Economics:

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