Time Value of Money

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Description of Time Value of Money. Explanation.

 

Definition Time Value of Money. Description.


The Time Value of Money is the fundamental financial concept that an amount of money in hand today is worth more than the same amount of money in the future. This is caused by the return that you could earn on investing the money or simply placing it in a bank account and receive interest.

Time allows one the opportunity to postpone consumption and earn interest. Not having the opportunity to earn interest on money is called Opportunity Cost.


There is also a risk factor included in the term, because $100 today is more certain than $100 in a year from now.


Examples of Time Value of Money

The Future Value of an amount PV in n years with interest rate r can be calculated as follows: FV = PV x (1 + r)n

Example. How much will 100 be worth in 2 years, presuming an interest rate of 4%?  FV = 100 x (1 + 0,04)2 = 108,16


The Present Value of an amount FV in n years from now with interest rate r can be calculated as follows: PV = FV x 1 / (1 + r)n

Example. How much is 100 in 2 years worth now, presuming an interest rate of 4%?  PV = 100 x 1 / (1 + 0,04)2 = 95,20


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Compare with: Net Present Value  |  Depreciation  |  Amortization  |  Rule of 72  |  Residual Value  |  Internal Rate of Return  |  Discounted Cash Flow  |  Time to Market

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