Time Value of Money

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rjonesx
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Definition

The time value of money is the greater benefit of receiving money now rather than later. It is founded on time preference.

Time Value of Money

Time value of money is a concept according to which the value money present at the current time is worth more than how much the same amount of money will be worth in future. This is because of the potential earning capacity money has. Regarded as one of the core principles of finance, it holds that if the money can earn interest, it is worth more the sooner it is in your hand. So basically, the time value of money incorporates the benefits of receiving the money now than later. It is based on the idea of time preference.

Investments are also highly dependent on the idea of time value of money. Hence, if an investor expects to get a favorable return on their investment in the future, they may forego spending their money now.

Calculation

There is a simple formula to calculate the time value of money:

PV = FV (1 + r)

Where:

PV = the present value of money

FV = the future value of the same amount of money

r = the interest rate applied to the amount

Thus, to calculate the future value of money, you have to discount it to an amount that equals the present value of money. This will give you an idea about how much the money you have right now will be worth in the future and you can take important decisions accordingly then.

From this formula, you can also calculate the present and future values of annuity, as well as, the present and future value of perpetuity.

Why is it better to Receive Money Now?

It is a universal fact that a person will prefer receiving any amount of money now, then receiving the same amount in the future. Why? This is because the interest rate applied on it will increase the net worth of the same money and make it more than the amount in hand today.

For example, if there is an interest rate of 5% applied on the $100 invested today. In a year’s time, the same amount will be worth only $95.24. Hence, the present value of money is greater than the future value of the same amount of money provided that an interest rate is applied on it.

Time Value Of Money FAQ

What is time value of money with example?

If $100 (the present value) is invested for 1 year at a 5% interest rate (the discount rate), then you would have $105(the future value) at the year’s end. According to this example, $100 today is worth $105 a year from today.

What do you mean by time value of money?

The time value of money (TVM) is the concept that the money you currently have has more worth than similar amount in the future because it has the potential to earn. This core principle of finance maintains that as long as the money can earn interest, it is worth more the sooner it is received.

Why time value of money is important?

The time value of money (TVM) is important to investors because a dollar on hand today has more worth than a dollar promised in the future.

How do you calculate time value of money?

To calculate time value of money, you’ll consider the payment now, the future value, the interest rate, and the time frame. The number of compounding periods during each time frame is also an important factor in the formula for time value of money.

What causes time value of money?

The three basic reasons to support the TVM theory are: First, a dollar earn interest over time when invested, giving it potential earning power. Also, money is influenced by inflation, eating away at the spending power of the currency over time, making it worth a lesser amount in the future.

What is time value of money used for?

The time value of money (TVM) helps you understand the worth of money in relation to time. It is a formula often used by investors to understand the value of money better compared to its value in the future.

Further Reading

  • The time value of money concept in Islamic finance – books.google.com [PDF]
  • An EOQ model for deteriorating items with price-and stock-dependent selling rates under inflation and time value of money – www.tandfonline.com [PDF]
  • Public Discovery of the Concept of Time Value of Money with Economic Value of Time – www.emerald.com [PDF]
  • Inventory model for deteriorating items and time value of money for a finite time horizon under the permissible delay in payments – www.tandfonline.com [PDF]
  • Economic production lot size for deteriorating items taking account of the time-value of money – www.sciencedirect.com [PDF]
  • Role of the time value of money in financial reporting – search.proquest.com [PDF]
  • An inventory model for ameliorating and deteriorating items taking account of time value of money and finite planning horizon – www.tandfonline.com [PDF]
  • Supporting financial decision-making based on time value of money with singularity functions in cash flow models – www.tandfonline.com [PDF]
  • The concept of the time value of money: A Shari 'ah viewpoint – platform.almanhal.com [PDF]

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