Final answer:
The present value of a future cash flow is computed by multiplying the future cash flow value with the discounting factor. The discounting factor takes into account the time value of money.
Step-by-step explanation:
The present value of a future cash flow is computed by multiplying the future cash flow value with the discounting factor. The discounting factor is used to adjust the future cash flow to its present value, taking into account the time value of money. It is calculated by dividing 1 by the interest rate raised to the power of the number of periods.
For example, if the future cash flow is $1,000 and the interest rate is 5% for 4 periods, the present value can be calculated as:
- Discounting factor = 1 / (1 + 5%)4 = 0.8227
- Present value = $1,000 x 0.8227 = $822.70