Glossary
Present value
What a future sum of money is worth today, found by discounting it at a rate that reflects time and risk.
Present value (PV) is the amount of money today that is equivalent to a payment you will receive in the future. A dollar a year from now is worth less than a dollar in hand, because the dollar in hand could be invested in the meantime and because the future payment might not arrive. Present value turns future cash into today's terms, which is the foundation of how bonds, stocks and whole businesses are valued.
How it works
Present value runs Compound Interest in reverse. Instead of growing a sum forward, you shrink a future sum back to today using a Discount Rate.
For a stream of payments, you discount each one separately and add them up. A bond's price is the present value of its coupons plus its face value; a Discounted Cash Flow (DCF) model does the same with a company's projected free cash flows.
Why the rate matters so much
Two forces drive present value: time and the discount rate. Distant payments shrink a lot, and they shrink faster when rates rise. That is why long-duration assets, such as long-term bonds and growth stocks whose profits lie far in the future, tend to fall hardest when interest rates jump.
Choosing the rate is the judgment call. Many analysts start from a Risk-free rate such as a Treasury yield and add a Risk premium for uncertainty. Small changes matter: in the example above, moving from 4% to 9% cut the value by about 21%.