What is the formula for calculating the present value of future cash flows?

The formula for calculating the present value (PV) of future cash flows is indeed represented by the equation PV = CF / (1 + r)^n. This formula is grounded in the concept of time value of money, which posits that a dollar today is worth more than a dollar in the future due to its potential earning capacity.

In this formula:

• CF denotes the cash flow expected at a future date.

• r represents the discount rate, which reflects the risk and time value of money.

• n is the number of periods until the cash flow is received.

The denominator (1 + r)^n adjusts the future cash flow back to its present value. Essentially, as the time period (n) increases, and/or as the discount rate (r) increases, the present value decreases. This reflects the opportunity cost of capital: you forgo the possibility of earning a return on the money if you do not receive it today.

This formula is fundamental in finance, particularly when analyzing investments or valuing cash flows that occur at different points in time.