How is present value calculated?

The correct method for calculating present value involves taking the future cash flow and discounting it back to its present value using a discount factor. In financial terms, this is done by applying the formula where you multiply the future cash flow by the discount factor.

The discount factor is derived from the concept of the time value of money, which posits that a dollar today is worth more than a dollar in the future. The discount factor usually reflects the interest rate and the number of periods until the cash flow is received. By multiplying the future cash flow with this factor, you adjust it to reflect its present equivalent, accounting for the time value of money.

As a result, this method provides a more accurate assessment of the value of future cash flows in today's terms, enabling better decision-making in financial management and investment scenarios.