If someone were to offer you $500 now or $500 a year from now, which would you choose? Without question, most people would choose to have $500 now rather than a year from now. As the old saying goes, a bird in hand is worth two in the bush. A more compelling question, however, is whether you would rather have $500 now or $550 a year from now? Or, how about $500 now or $800 a year from now?
Perceived value is a topic of unending fascination that affects all aspects of the business world. Art, in particular, may be one of the most interesting areas of study on perceived value. The value of most goods is generally determined by the price of the components that go into making it, the time and labor involved and a margin for profit. Yet art often requires very little material investment and may take as little as a few hours or weeks to complete but can still potentially garner millions of dollars depending on the piece. And what makes people spend millions of dollars on one piece but not another very similar one?
Present value is a component of perceived value. The value of something today is often greater than the value of the same thing in the future. In some ways, this makes sense because if you get $100 today, then in a year it may become anywhere from $110 to $200 depending on how you put it to work. If you get $100 a year from now, it has lost the time potential to become more valuable. By and large, the sooner you receive a financial asset the more valuable it is. Conversely, however, if you were to receive an interest-bearing savings bond, then the future value of the bond is actually higher than its present value.
While there are many different ways to calculate present versus future value, a basic formula for calculating present versus future value is:
- The total amount of money or financial asset in the future
- The amount of time it takes to get that money (i.e., future value.)
- The interest rate or rate of return you may receive if the current money was invested today
- How you’ll calculate that interest