Time Value of Money

See Also:
Valuation Methods
Adjusted Present Value (AVP)
Net Present Value Method
Internal Rate of Return Method
Required Rate of Return

Time Value of Money (TVM)

Time value of money is the difference between an amount of money in the present and that same amount of money in the future. Having money now is more valuable than having money later.

The present amount is called the present value, the future amount is called the future value, and the appropriate rate that relates the two amounts is called the discount rate.

Present Value = Future Value / (1 + Discount Rate)

Future Value = Present Value x (1 + Discount Rate)

Time Value of Money Examples

Now, let’s look at time value of money examples. If you invest $100 (the present value) for 1 year at a 5% interest rate (the discount rate), then at the end of the year, you would have $105 (the future value). So, according to this example, $100 today is worth $105 a year from today.

$105 = $100 x 1.05

$100 = $105 / 1.05

Likewise, $100 a year from today, discounted back at 5%, is worth only $95.24 today.

$95.24 = $100 / 1.05

To calculate the time value of money for a period longer than one year, you simply raise the discount factor by the appropriate number of time periods. For example, to calculate the future value of $100 at 5% for 5 years:

$127.63 = $100 x (1.05)5

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time value of money, Time Value of Money Examples

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