present value

Present Value Tool You Can Use for Basic Finance Calculations

The present value calculator can be a useful tool in some key basic personal finance computations. For example, you can determine an estimate of approximately how much you may be able to borrow to buy a home, given a specific monthly payment amount, interest rate, and loan term.

Present Value Calculator:








Instructions

Make changes to the input fields above, and click “Calculate” to get your results.

Future Value:

The lump sum amount which you will have at the end of a specified time period. As an example, if you’re looking to find out how much you need now (present value) to save $600,000 by retirement, you would enter this number as the future value. On the other hand, if you are determining the present value of a loan, this field (the future value) will generally be zero, since the loan will usually be fully amortized by the end of the loan term. See the examples below for a better understanding.

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Annual Rate:

This can be an annual interest rate on a loan, or an average investment return on a portfolio, for example. The rate is adjusted automatically in the calculation when you choose the compounding frequency. For example, let’s say you enter 6% as the annual rate and “semi-annual” for the compounding frequency. In this case, a periodic rate of 3% (6% / 2) will be used in the calculation.

Number of Years:

The time period or time horizon, stated in years, which you want to use in your calculation. Similar to the “annual rate” above, this number is automatically adjusted in the calculation based on the compounding frequency selected. For example, let’s say you are computing the present value of a 30 year mortgage loan. You would enter 30 for the number of years. But the compounding periods used in the calculator will be 360 (30 x 12) if you choose “monthly” compounding,” which is the case with mortgage loans.

Periodic Payment:

The amount of any payment per compounding period. Enter this number as a negative since you are paying this amount. An example of this would be a loan payment or a contribution to an investment account.

If you are receiving periodic payments, then you would enter this amount as a positive. An example of this would be a withdrawal from a retirement account.

You can enter a future value (see above), periodic payments, or both.

Make sure you match the periodic payment with the compounding frequency chosen. For example, if you choose monthly compounding, the periodic payment will be the payment made each month. If you choose quarterly, it will be the total payments you make for each three month period, and so on.

Type of Payment:

This input only applies if there are periodic payments. The default value of “End of Period” implies payments are made at the end of each compounding period (“in arrears”). However, you can also choose to calculate the present value as if the periodic payments are made at the beginning of each period (“in advance”).

Compounding Frequency:

The frequency with which returns and any periodic payments are added to the running balance on which the rate is applied. For example, with a bank savings account or a mortgage loan the interest compounds monthly. A stock dividend reinvestment plan, on the other hand would compound quarterly since most common stocks pay dividends every three months.

Present Value Result:

Note that the present value given by the calculator can be positive or negative. If it is positive, it represents money provided to you at the present time. An example would be loan proceeds such as from a mortgage. A negative amount represents money you must provide at the present time to get to the future value (based on the terms entered). An example would be a beginning or present value in your investment account which will be invested to get to the future value indicated.

Determine How Much You May Be Able To Borrow

You are looking to buy a home. Let’s say that based on your current budget, you can only afford to pay $850 monthly on your mortgage payment (principal and interest). How much would you be able to borrow? Let’s assume that you want a 30 year loan and based on your credit score you can get an interest rate of 4.5%. Plug these numbers into the calculator above and you get a loan value of $167,756.99. The number appears as a positive since you will be receiving the loan proceeds.

The inputs are as follows:

future value: $0 (the balance of the mortgage will be zero at the end of the loan term)

annual rate: 4.5%

number of years: 30

periodic payment: -$850 (principal and interest mortgage payment for each month; enter as a negative since you are paying this amount)

type of payment: end of period (default) – Mortgage payments are made in arrears (at the end of each month)

compounding frequency: Monthly – The mortgage loan interest is compounded monthly since this is the frequency of the mortgage payments.

You can change some of the terms to see how that would affect the loan amount. For example, you can try a 15 year loan term, or a different interest rate. Maybe you can even make some budget cuts and even up your monthly payment maximum.

You can also perform similar calculations for car loans, business loans, etc.

Use Present Value To See If You Are On Track For Retirement

You can also use this tool to see how you may be progressing with retirement. For example, let’s say that you have estimated that you will need approximately $850,000 at retirement when you are 65. You are also currently 45 years old and save approximately $10,000 per year towards retirement.

Based on historical returns, you estimate that your portfolio asset mix will generate an average return of about 8% per year. Let’s also say that you reinvest your investment earnings and additional contributions on a quarterly basis (every three months). Plug these numbers into the calculator, and you get a present value of $62,302.76. This is basically an estimate of approximately how much you should have accumulated by now in order to meet your stated goal.

The number appears as a negative in the results since this is an amount you must provide into your investment account.

The inputs are as follows:

future value: $850,000 (the amount you estimate you will need at retirement)

annual rate: 8.5% (estimated annual investment return of your portfolio)

number of years: 20 (estimated retirement date (65) minus current age (45)

periodic payment: -$2,500 ($10,000 annual savings divided by 4 (quarterly compounding; enter as a negative since you are paying this amount into your investment account)

type of payment: end of period (default) – Assume you will make your savings investments at the end of each period (quarterly in this case).

compounding frequency: Quarterly – We are assuming you will make new investments (new contributions and reinvested earnings) each quarter (every three months).

Again, this is just an estimate based on inputs which may vary over time. But if you find that you may be lagging, you can cut back on some expenses and maybe increase your savings. Or you may target a higher investment return by shifting your portfolio allocation to a heavier stock weighting, for example.

You can also use the same type of calculation for other savings goals.

Conclusion

This calculator assumes fixed payments and rate input variables throughout the time horizon used. For something like a fixed rate mortgage, this is not an issue. But for predicting future savings goals and investment returns, it does not allow for more flexible and detailed analysis.

More detailed inputs can be helpful. For example, your asset mix can change as you get closer to retirement (may affect investment rate of return). Or your savings may change based on income or other factors.

But greater detail can also provide a false sense of accuracy. The future is impossible to predict for many variables. For example, you don’t know exactly how much you will be able to save each year, or how much your investments will earn.

Nevertheless, you can use this tool to perform basic finance calculations in an efficient manner.  Using estimated averages for the input variables can give you some useful ballpark figures.

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