Discounting

Discounting is the process of moving CFs back in time.

Once all the CFs are moved back in time to timestamp 0, they can be aggregated (added/subtracted).

Present Value $PV_t(CF_i)$ is the present value of the cash flow $CF_i$ at a previous timestamp t. The moved back CFs denote the present values of the cash flows today i.e. at timestamp 0.

Simple Example

How much do you have to save today to withdraw $100 at the end of each year for the next 4 years,
if you can earn 5% per annum?

The first step is to place the CFs on the timeline:

Now, calculate their present values (at timestamp 0) by discounting:

Now, simply aggregate the present values:

Thus, we need to save $354.60 today to be able to withdraw $100 at the end of each of the next 4 years, earning 5% per annum.