Definition of Time Value of Money
Time Value of Money Definition – “The principle that a dollar received today is worth more than a dollar expected at some point in the future”.
It is the concept that states that the money available right now is worth more than the same amount of money after a future date. The reason behind this is the earning capacity available to the future date. The money earned today has the ability to earn interest in the future date. Hence the worth of money in hand today is more than the money received on some future date.
A rational investor always like to receive the money today rather than tomorrow. As the investor can put it in either back or invest in stock market. In return she/he gets interest or dividend. Thereby increasing the worth of the money. In simple words, the money which receives interest compounds in value.
In financial terms, TVM deals with how much the present value of investment will grow in future date. The value received on future date is known as future value. The difference between the two depends upon how many compounding years involve in it. Future value determines how much money one earn after certain years if interest compounded annually.
Variables of TVM
Most important variables for determining the TVM is given below –
- Future Value (FV)
- Present Value of Money (PV)
- interest rate (i)
- number of compounding years per year (n)
- number of years (n)
Time value of Money Formula
FV = PV × (1+ i/n) ^ (n ×t)
Time Value of Money Example
Ram has Rs 10,000 that he invested for one year @ 12%, what would be the future value?
Future value = 10,000 × (1+ 12%/1) ^ (1 × 1)
Why TVM is Important?
- To compare the future value of the payments received.
- It provides the true and clear picture about the investments that are made.