Finance -- Time Value of Money

Time Value of Money

Time value of money often called as TVM is a basic but an important concept in financial management. This concept is very helpful in solving financial problems related to loans, mortgages, interest rates, leases, savings and annuities.

Basically the concept of TVM is that the amount of money (say 5 $) you have is today is worth more than the exact amount of money (say 5 $) you will have in the future. Lets us discuss Time Value of Money with an example:

Let us suppose that you have started your own business with 1000 $ and you know in small amount of time, you are going to need 1000 $ more to continue further. Now you will be left with two choices -

(i) Borrow $ 1000 form a friend right now as you need them in the future.
(ii) Borrow $ 1000 from a friend when you actually need the money which is 5 years from now.

If you take the first choice, you will have 1000$ which you can put in a bank.

Suppose we have $ 1000 with us and we deposit it in a bank which pays 6% annual interest. Then after 1 year the amount in bank will be:
$ 1000 + $ 1000 * 6 % interest = 1000+ 60= $ 1060
If we keep the amount in bank for 1 more year then the amount in bank will be:
$ 1060 + $ 1060 * 6% interest = 1060 + 63.6= $ 1123.6
Hence we observe that in second year the interest amount has increased by $ 3.6, this is due to the fact what we call as interest on interest. So interest on $ 60 @ 6% will give us $ 3.6. So from the above calculation of the interest, we can conclude that for an investment spanning for t years, the original $ 1000 investment will grow to $ 1000 × (10.6)n. For an interest rate of r and a span of n years, the future value of our investment will be:

Future value of $ 1000 = $ 1000 + (1 + r)ⁿ

The table below will help us to get a clear picture:


So after 5 years, the interest on the principle amount of $ 1000 will be $ 338.2. If we would have ignored the concept of compound interest, the interest earned for this period would have been only $ 300.

Present Value and the Future Value –

Present value is defined as what return your investment will give you now if you spend it today itself. Future value is the total amount of money that a saving with a fixed or compounded interest rate will grow to by any future date. The tutors at Tutorsbiz provides the students with detailed concepts of the present and the future value as they have a high level of expertise when it comes to solving the basic questions and problems.

Conclusion –

These calculations clearly show that time literally means money - the worth of money you currently have is not the same as it will be in the future and vice versa. Hence, it is very important to know how we can calculate the time value of money so that we can distinguish between the worth of investments that offer returns at different times.

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Topics on which Assignment Help and Homework help is available for Time Value of Money are -

• Interest Rate
• Number of Periods
• Payments
• Present Value
• Future Value
• Loan Authorization
• Cash Flow Diagram

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