The time value of money (TVM) is the idea that money available at the present time is worth
more than the same amount in the future due to its potential earning capacity. This core
principle of finance holds that, proided money can earn interest, any amount of money is worth
more the sooner it is received.
Time Value of Money (TVM) is an important concept in financial management. It can be used to
compare investment alternatives and to solve problems involving loans, leases, savings.
TVM help us knowing the value of money invested. As time changes value of money invested on
any project/firm also changes. And its present value is calculated by using “mathematical”,
which tell us the value of money with respect of time. i.e.
PV = present value
FV = future value (money to be received in the future)
i – discount rate
n = number of periods until fv is received
Reasons for Time Value of Money
There are certain reason which determine that money has time value following are the reasons.
1. Risk and Uncertainty – As we know future is never certain and we can’t determine the risk
involved in future because outflow of cash is in our hands as payment where there is no
certainty for future cash inflows.
2. Inflation – in an inflationary economy, the money received today, has more purchasing power
than the money to be received in the future. In other words a peso today represents a greater
real purchasing power than a peso in the future
3. Consumption – individuals generally prefer current consumption to future consumption
4. Investment opportunities – an investor can profitably use the received money today to get
higher return tomorrow or after a certain period of time
e.g if an individual is given an alternative either to receive P 10,000 now or after one year, he will prefer
P10,000 now. This is because, today, he may be in a position to purchase more goods with this money
than what he is going to get for the same amount after one year.
Importance of TVM
1. In investment Decisions – small businesses often have limited resources to invest in business
operations, activities and expansion. One of the factors we have to look at is how to invest, is
the time value of money
2. In Capital Budgeting Decisions – When a business chooses to invest money in a project – such as
an expansion, a strategic acquisition or just the purchase of a new piece of equipment – it may
be years before that project begins producing a positive cash flow. The business needs to know
whether those future cash flows are worth the upfront investment
Valuation concepts
The time value of money establishes that there is a preference of having money at present than a future
point of time . It means:
If an individual is given an option A to receive P10,000 now or option B after three years, he will
prefer P10,000 now because although the amount is the same, you can do much more with the
money if you have it now because over time you can earn more interest on your money. By
receiving P10,000 today you can increase the future value of your money by investing and
gaining interest over a period of time. For option B, you don’t have time on your side, and the
payment received in three years would be your future value.
The Time Value of Money
Would you prefer to have P 1 million now or P 1 million 10 years from now?
Of course, we would all prefer the money now! This illustrates that there is an inherent monetary value
attached to time.
What does Time Value of Money Mean?
The concept that money available today is worth more than the same amount of money in the
future
This preferences rests on the Time value of money
Thus, a money received today is worth more than a money received tomorrow, why?
This is because that
A money received today can be invested to earn interest
Due to money’s potential to grow in value over time
Because of this potential, money that’s available in the present is considered more valuable the
same amount in the future
Time Value of Money is dependent not only on the time interval being considered but also the
rate of discount used in calculating current or future values.
Based on this, we can use the time value of money concept to calculatehow much you need to
invest or borrow now to meet a certain future goal.
Uses of Time Value of Money
Time Value of Money or TVM is a concept that is used in all aspects of finance including:
Bond valuation
Stock valuation
Accept/reject decisions for project management
Financial analysis of firms
And many more!
The Future Value of Money
Future value is the value of an asset at a specific date in the future.
It measures the nominal future sum of money that a given sum of money is ‘’worth” at a
specified time in the future assuming a certain interest rate, or more generally, rate of return
Actually, the future value does not include corrections for inflation or other factors that affect
the true value of money in the future
Time Value of Money Concept
In simple terms the concept implies that money today is always better than money tomorrow
Summary and Conclusions
The financial manager uses the time value of money approach to value cash flows that occur at
different points in time
A peso invested today at compound interest will grow a larger value in future. That future value,
discounted at compound interest, is equated to a present value today
Time Value of Money
Why Time?
Why is TIME such an important element in your decision?
TIME allows you the opportunity to postpone consumption and earn INTEREST.
Time Value of Money
Time value of money means that the value of money is different in different time periods. The
value of money received today is more that the value of same amount receivable at some other
time in future
The difference in the value of money today and tomorrow is referred as time value of money.
Therefore, given a choice of receiving a sum money today or in the future, a rational person will
always choose to receive the money now as it has more value today than in the future
Time Value of Money
Time value of money means that the value of a unit of money is different in different time periods. The
value of a sum money received today is more valuable than the money received after sometime.
Time Value of Money
The time value of money compares the future value with the present value of an amount of
money
Future value is the amount to which an amount of money will grow in a defined period of time
at a specified investment rate
Definition of Time Value of Money (TVM)
The idea that money available at the present time is worth more than the same amount in the
future due to its potential earning capacity. This core principle of finance holds that, provided
money can earn interest, any amount of money is worth more the sooner it is received.
Reasons for Time Value of Money
Three reasons for time value of money:
Attitude: we want to spend it now than later to get something that we need or want (i.e.
satisfaction that you get from something today is greater than satisfaction that you will get from
the same thing in future)
Availability of opportunities: we have a good use of funds now to earn greater income more
than sufficient to pay back in future
Inflation: as prices of goods and services increase over time, the same peso can buy less and less
in future.
Time Value of Money
Some people put their money in a bank account, some make investments in stocks and bonds
Different people follow different strategies to keep their money on the move.
All of them consciously or unsconsciuosly realize tiem is the biggest enemy of idle money
So, the concept of time value of money alwaysinfluences our decision about what we intend to
do with our money.
