Scribd
Upload
15 views6 pages

Compounding Interest Future Value Step by Step Approach 11032024 064036pm

The document discusses the concept of time value of money, which recognizes that the value of money is different at different points in time. It provides a definition and formula for calculating time value of money as well as examples. Additionally, it covers parameters like inflation and opportunity cost that affect time value of money and the importance of the concept in financial management and decision making.

Uploaded by

Abdul hanan Malik
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
15 views6 pages

Compounding Interest Future Value Step by Step Approach 11032024 064036pm

The document discusses the concept of time value of money, which recognizes that the value of money is different at different points in time. It provides a definition and formula for calculating time value of money as well as examples. Additionally, it covers parameters like inflation and opportunity cost that affect time value of money and the importance of the concept in financial management and decision making.

Uploaded by

Abdul hanan Malik
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 6

Week 3 11-3-24

Time value of Money Chapter 3 Book page 66


by Van Horne and Wachowicz

P.T. Barnum Quote: “Money is good for nothing unless you know
the value of it by experience.”

“A Dollar today is worth more than a dollar tomorrow.”

It is a well-known fact that time is precious. Every business has started to make
a profit.

‘Time value of money’ is central to the concept of finance. It recognizes that the
value of money is different at different points of time. Since money can be put
to productive use, its value is different depending upon when it is received or
paid.

A small amount available today is crucial than the lump sum due in the future.
This indicates that time decides the value of money. The difference in the value
of money today and tomorrow is referred to as the time value of money.

Therefore, the time value of money is defined as the money that is present with
any individual currently. The money that is available at the moment will allow
businesses to invest it for expansion, to pay salaries for its employees, to
purchase raw materials, etc. The money which is due for the future is only on
papers and does not add any value in the present.

Time value of money is commonly identified as TVM by finance professionals.


It is called a present discounted value as well.
Time value of money means that a sum of money is worth more now than the
same sum of money in the future. This is because money can grow only
through investing. An investment delayed is an opportunity lost.

If it is not invested, the value of the money erodes over time. If you hide
$1,000 in a mattress for three years, you will lose the additional money it could
have earned over that time if invested. It will have even less buying power
when you retrieve it because inflation has reduced its value.

As another example, say you have the option of receiving $10,000 now or
$10,000 two years from now. Despite the equal face value, $10,000 today has
more value and utility than it will two years from now due to the opportunity
costs associated with the delay. In other words, a payment delayed is an
opportunity missed.

Formula for Calculating Time Value of Money

 FV = Future value of money


 PV = Present value of money
 i = interest rate
 n = number of compounding periods per year
 t = number of years

Based on these variables, the formula for TVM is:

FV = PV x [ 1 + (i / n) ] (n x t)

Time Value of Money Examples

Assume a sum of $10,000 is invested for one year at 10% interest compounded
annually. The future value of that money is:

FV = $10,000 x [1 + (10% / 1)] ^ (1 x 1) = $11,000


Parameters of TVM

1. Inflation – It reduces the purchasing power of money as it raises the cost


of goods or services. The same amount of money can purchase lesser
goods in the future.
2. Opportunity cost – It is the loss associated with the investment and the
profit linked with them because of the obligation of money in another
investment within the fixed time duration.
3. Risk – It relates to the risk involved in investment to be undertaken by
each investor while investing.

Importance of TVM

Understand the time value of money importance from the following section
from a financial management perspective.

1. Money in hand will help businesses to invest and grow the


business. According to the saying “Make hay while the sun shines.” One
needs to have money in hand when there is a need and an opportunity.
You are taking advantage of a good situation or of good conditions. You
are making the most of your opportunities.
2. The future is uncertain and hence time value of money in financial
management plays a crucial role to manage finances and generate profit
from the business.
3. The concept of time value of money is of immense use in all financial
decisions.
4. The time value concept is used to compare the investment alternatives
to judge the feasibility of proposals. In choosing the best investment
proposals to accept or to reject the proposal for investment.
5. In determining the interest rates, thereby solving the problems involving
loans, mortgages, leases, savings and annuities.
6. To find the feasible time period to get back the original investment or to
earn the expected rate of return.
FV 1 = PV (1+i)1

= PV (1+0.05)1
= $ 105
FV 2 = PV (1+i)2

= PV (1+0.05)2
= $ 110.25
FV 3 = PV (1+i)3

= PV (1+0.05)2
= $ 115.76

You might also like