The time value of money (TVM) is the idea that money today is worth more than money in the future. This is because money today can be invested, used, or grown.
Why TVM is important?
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- TVM is a key consideration when making investment decisions.
- It helps investors compare the present value of future returns from different investments.
- It helps companies determine if a project will yield a satisfactory return.
TVM components
- Present value: The value of money today
- Future value: The value of money in the future
- Interest rate: The rate at which money grows over time
- Time period: The length of time between the present and the future
- Payment installments: The amount of money paid out over time.
Calculating TVM
- TVM can be calculated using the present value method, also known as the discounting technique.
- The present value method applies a discount rate to the future amount of money to arrive at its present value.
Example of TVM
- If you invest $100 today, you’ll get more returns than if you invest the same amount two months from now.