Present Value (PV) and Discounted Cash Flow (DCF) are terms we frequently hear in the financial world. They are widely used in corporate finance, banking, valuation, and even personal investment planning. But why are they so important?
Let us begin with a very simple question.
Suppose you invest in an LIC policy today and receive a lump sum amount after 10 years.
Now ask yourself:
Will that amount received after 10 years have the same value as that amount has today?
At first glance, it appears to be an ordinary question. But in reality, it has deep financial significance.
Because over time:
- Inflation reduces purchasing power
- Opportunity cost exists
- Risk and uncertainty increase
- Money has earning capacity
Therefore, money received in the future does not carry the same value as money in hand today.
This concept is not just theoretical. It plays a crucial role in:
- Business investment decisions
- Capital budgeting
- Project evaluation
- Loan decisions
- Personal financial planning
Whether a company is investing crores in a new plant or an individual is choosing between two insurance policies, the logic remains the same:
Future money must be evaluated in today’s terms.
To understand this more clearly, let us enter into a simple classroom conversation and see how Present Value and Discounted Cash Flow actually guide our financial decisions
Professor: if I give you Rs.10,000 today or Rs.10,000 after 3 years — which will you choose?
Students say: Today.
Professor: why? the amount is same.
Students:
- Because of interest
- Because of inflation
- Because money grow
- Because future is uncertain
That is the foundation of Time Value of Money (TVM).
Professor: How much was a movie ticket 10 years ago?
May be Rs.120.
Today? Rs.300.
So, if someone promised Rs.120 after 10 years — is it equal to Rs.120 today?
No.
Because:
- Purchasing power falls
- Inflation reduces value
- Opportunity cost exists
Now they emotionally understand the concept.
Use a simple bank example:
If you invest ₹10,000 at 10% for 1 year:
FV=PV(1+r)n
Money grows because of compounding.
Now compute verbally:
FV = 10,000 × 1.10 = 11,000
So: Rs.10,000 today = Rs.11,000 next year.
Professor: If someone promises Rs.11,000 next year, how much is it worth today?
Reverse the formula:
PV=FV/(1+r)n
This is Discounting.
So, DCF is future money is converted into today’s value before taking a decision.
Professor: future money must be discounted to compare with today’s money.
This is the heart of:
- NPV
- PI
- IRR
- DCF method
- Discounted Payback Period
Suppose:
You invest Rs.1,00,000 in a shop.
Expected returns:
Year 1 → 40,000
Year 2 → 40,000
Year 3 → 40,000
Total cash inflow = Rs.1,20,000
Professor: Is it profitable?
Students: yes! Profit = 20,000.
Professor: but what about time? Now introduce discounting at 10%.
You discount each cash flow and you will find future money is worth less.
Profit in accounting ≠ Profit in finance
This is where NPV becomes powerful.
| Technique | Consider Time Value? |
| Payback Period (PBP) | No |
| Discounted Payback | Yes |
| NPV | Yes |
| PI | Yes |
| IRR | Yes |
Professor: Why is PBP weak?
Because ₹40,000 in Year 1 and ₹40,000 in Year 3 are treated same.
But financially, they are not equal.
Professor:
Imagine you get salary of Rs.50,000 per month.
Would you accept:
- Rs.6,00,000 at end of year
instead of - Rs.50,000 every month?
No.
Because:
- Monthly money can be invested
- Can meet expenses
- Has earning capacity
That difference is DCF logic: discounting every future cash flow to today’s value and then comparing it with today.
