Finance · level 1
Present and future value
One cash flow, one discount factor. Build the factor from the percentage blocks you already drill: 10% a year for two years is roughly a 17% haircut, not 20%.
Worked example: $1.3M received in 1 year, discounted at 5%. Present value?
cash flow$1.3M
years1
discount factor0.95
PV$1.24M
Step by step
- 1
Discount factor
1 / 1.05^1 = 0.95
- 2
Apply it
$1.3M × 0.95 = $1.24M
- 3
Mental shortcut
Each year at 5% knocks off roughly 5% of what is left — 1 years ≈ −4.8%.
$1.3M received in 1 year, discounted at 5%. Present value? = 1,238,095
The theory behind it
Intuition
A future cash flow is worth less today because capital has an opportunity cost. Dividing by (1+r)^t is exactly undoing compounding.
Common pitfalls
- ×Off-by-one on t — a flow at the end of year 1 is discounted once, not twice.
- ×Using the same rate for cash flows with very different risk.
In the interview
Any 'is this investment worth it' round starts here.