Time Value of Money

Time Value of Money

“The time value of money is a necessary concept of finance that allows us to equate money from its present value (PV) future value (FV), present value-annuity (PVA), and future value annuity (FVA).” (Wilkipedia, 2006. Money that is deposited in a savings account earns interest, but the future value of that amount will be equal to if not less, in the future. This is the prime reason why people prefer receiving money today rather in the future. Receiving the funds today allows them to invest their money and receive a greater increase presently oppose to the future. As mentioned earlier, there are several financial applications of time value of money. We will discuss such applications below in further detail.

Future Value/Single Amount

“Future value measures what money is worth at a specified time in the future assuming a certain interest rate. This is used in time value of money calculations” (Wilkipedia, 2006). Future value with compound interest and without compound can be calculated two ways: without compound interest FV= PV x (1 + rt)/ 6050=5000 x 1 + 0.10)2. PV being the principal, t being the period of years, and r being the annual interest rate. With compound interest: FV=PV x (1 + I)n. PV being the present value, n being the number of compounding years or periods(month to month) and I being the interest rate per period.

Present Value/Single Amount

Present value is the exact opposite of the future value. The present value “of a future cash flow is the nominal amount of money to change hands at some future date, discounted to account for the time value of money). A given amount of money is always more valuable sooner then later due to the fact this enables one to take advantage of investment opportunities. Because of this, present values are smaller than corresponding future values”(Wilkipedia, 2006).

Example: (Wilkipedia, 2006)