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Present value models are analytical processes companies go through in order to determine the financial viability of a project. In short, these models take a future dollar amount and discount it back to current value, making it easier for a company to determine the potential profitability among several projects. Different types of present value models include present value, net present value, and formulas for lump sums or streams of cash payments. Different techniques may be possible depending on the inputs that go into the models. One good thing about these models is the flexibility offered for making accurate computations.
A basic present value formula takes a financial dollar amount in some future period and discounts it back to the current period. Companies often use the lump sum formula to measure the financial returns on various investments. Present value models that only use the present value feature may not have any large expenses associated with them, meaning the company will not pay money for an investment. Multiple types of formulas exist for the present value model. Companies can select which one works best for a given situation and discover the best analytical method for determining the present value of a dollar amount.
The net present value formula is slightly different than the standard present value models in use by companies. The formula for computing the present value of a financial dollar amount is the same as previously discussed. The difference is that the present value calculated from the formula is then compared to the costs associated for the project. For example, if a project will cost several thousand dollars to start, then the present value of future financial returns has the project start-up costs subtracted from it. If the result is positive, then the project is a good decision; if the result is negative, then the project is usually not started.
Different types of present value models are available for different financial scenarios. The models are different for a lump sum or a stream of cash payments. Companies need to look at each project in terms of financial returns and then decide which present value formula will work best for the scenario. The calculation portion of the process is slightly different, though not too onerous if the project is a stream of cash flows. The results are typically quite different, though, as financial returns spread out over several years are usually less in terms of present value than a single sum.