Let’s get the formula for PV out of the way first as it will pave the way for a better understanding of the concept.
PV = FV / (1+r)n
PV = Present Value
FV = Future Value
r = rate of interest
n = number of years
This concept basically means that money in present is more valuable than the same amount of money in the future. For example, the stuff that you can get for $100 today is much more than what you would get for $100 five years down the line.
Let’s take another example. If you receive $10,000 today and deposit it into a bank earning 4% interest per year. One year from now, you would have $10,400.
So Present Value (PV) of $10400 when r is 4% (or 0.04 for calculation) and n is 1 year is $10000. $10400 is the Future Value (FV) here.
Now, the important question, why should you learn the formula of PV from PMP perspective?
In the exam, you could be asked to calculate PV. At the same time, you can also come across a question or two based on NPV or Net Present Value. NPV is used as a project selection technique to make sure the project is worth doing.
The initial investment on the project is subtracted by the total present value to arrive at NPV. Ideally, you won’t be asked to calculate NPV so don’t worry if the previous sentence was a bit too much to digest but the thumb rule is to select the project with the highest NPV.
Let’s look into a sample question for more clarity,
There are 4 projects to be chosen from, Project A has NPV of $32500, Project B has NPV of $35000, Project C has NPV of $45000 and Project D has NPV of $10000, which project should be chosen?
A. Project A
B. Project B
C. Project C
D. Project D
The answer is Project C as it has the highest NPV.
Check more articles on Cost Management