{"id":4339,"date":"2021-05-15T20:34:29","date_gmt":"2021-05-15T19:34:29","guid":{"rendered":"https:\/\/www.simtrade.fr\/blog_simtrade\/?p=4339"},"modified":"2025-12-08T20:09:00","modified_gmt":"2025-12-08T20:09:00","slug":"how-compute-present-value-asset","status":"publish","type":"post","link":"https:\/\/www.simtrade.fr\/blog_simtrade\/how-compute-present-value-asset\/","title":{"rendered":"How to compute the present value of an asset?"},"content":{"rendered":"

\"William<\/a><\/p>\n

In this article, William LONGIN<\/a> (EDHEC Business School, Global BBA, 2020-2024) elaborates on the concept of Present Value<\/em>.<\/p>\n

What is present value?<\/h2>\n

The present value (PV) of an asset is usually computed as the value of the stream of its future cash flows discounted at a given rate of return. In the calculation of the present value of an asset, there are two inputs: the expected future cash flows generated by the asset and the discount rate which takes into account the risk on the future cash flows.<\/p>\n

The discounting operation takes into account that an amount of money today is worth more than the same amount tomorrow. \u20ac100 lent or invested today at an interest rate of 10% is equal to \u20ac110 in one year. If you are to receive \u20ac100 in one year, you can borrow \u20ac90.90 to get this money today. In one year, you will have to repay the amount borrowed \u20ac90.90 and the interests \u20ac9.10, that is a total cash flow of \u20ac100 (that you will pay with the \u20ac100 that you are supposed to receive in one year). This refers to the concept of time value of money, best illustrated by the following quote: \u201cRemember that time is money\u201d – Benjamin Franklin (1748).<\/p>\n

How is present value computed?<\/h2>\n

The formula for the present value (PV) of a cash flow occurring at time t, denoted by CFt<\/sub>, discounted with the discount rate r, is given by:<\/p>\n

\"Present<\/p>\n

The above formula can be used to illustrate the time value of money. What is the present value of \u20ac100 obtained in 1 year, 5 years and 10 years? The table below gives the present value by discounting \u20ac100 obtained in 1 year, 5 years and 10 years with a discount rate of 10%. Present value shows that money received in the future is not worth as much as an equal amount received today.<\/p>\n

\"Present<\/a><\/p>\n

\"Download<\/center><\/p>\n

This formula can be generalized for a series of cash flows, CFt<\/sub>, from t=1 to t=T:<\/p>\n

\"Present<\/p>\n

Application 1: Computation of the present value of a stock<\/h2>\n

The concept of present value can be applied to value a stock.<\/p>\n

For a stock, the series of cash flows corresponds to the dividends paid by the firm to its stockholders at the end of each period t (DIVt<\/sub>) and the price PT<\/sub> at which the stock is supposed to be sold at time T (the horizon of the investor). The present value (PV) is then equal to the discounted value of this series of cash flows at the discount rate r.<\/p>\n

\"Present<\/p>\n

Let us take the example of the valuation of a stock paying a dividend every year. The expected cash flows for dividends is \u20ac4 in Year 1, \u20ac4 in Year 2, \u20ac5 in Year 3, \u20ac5 in Year 4, \u20ac7 in Year 5 (end of year). The expected resale price in Year 5 is \u20ac110 (end of year). Using a discount rate of 10%, the present value of this stock is equal \u20ac94.41.<\/p>\n

\"Excel<\/a><\/p>\n

\"Download<\/center><\/p>\n

In practice, there are three steps to compute the present value of a stock:<\/p>\n