Often we need to know the present value of amounts expected in the future. We calculate the present value by discounting the future amounts. In this situation discounting means 1) removing a specified amount of interest, or 2) adjusting for the time value of money. The concept is that receiving $1,000 in the future is less valuable than receiving $1,000 today.
If we assume that the time value of money is 10% per year, a net receipt of $1,000 one year from today will have a present value of $909. In other words, we discounted the future value of $1,000 by $91. With a time value of money of 10%, the $909 can be invested today and will grow by $91 ($909 x 10%) to be $1,000 in one year. Receiving a net amount of $1,000 in two years will have a present value of only $826. The reason is that $826 invested today at a compounded rate of 10% will grow to $1,000 in two years. If all amounts are certain, you will be in the same position whether you have $826 today or you receive $1,000 in two years.
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