Investment finance – Understanding the calculation method for present value

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Refresh flow value or income occurring on different dates in time determines the value for a given date using a discount rate. The values obtained are called present values or date values.

VA (E) = E ( F { } ) . ( 1 + t) ^ { -x } \ , \!

where

F is the flow
E ( F) \, \! is the expected flux at the time when it will be (or, was ) available ;

NB . : This expectation is equal to F for some flows (carried ) , or when defining a scale of credit.

t \, \! is the discount rate or the particular case , the actuarial rate ( rates expressed here are annualized ) ;
x \, \! is the time, expressed in years , date of update on the date of the flow ( so x is positive when the flow is the future , and negative for flow past )

NB . : By convention , x \, \! number of years is the actual number of days divided by 365.

VA ( F) \, \! represents the present value of the stream , the date by which the value (date of update) is calculated ;

NB . : Most often , the discount is the date chosen date. This is called current value rather than present value .

The valuation discount is therefore based on two essential elements: the assessment of future cash flows and the discount rate .

Assessment of future cash flows

There are situations where future cash flows are well known in advance: fixed rate , loan interest at fixed rates.

In other cases , future cash flows are hypothetical in definition. Assessment of future cash techniques are complex and depend on the nature of the investment. For example,

  • for an industrial machine , it will assess its production capacity that can turn into market value;
  • to estimate the value of a company or of its action, we anticipate future results, according to his business skills , technology and financial criteria ( balance sheet structure , contracts, debt , cash , etc.).
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