Time Value of Money

Topics: Debt, Time value of money, Interest Pages: 3 (1045 words) Published: October 18, 2008
Time Value of Money (TVM), developed by Leonardo Fibonacci in 1202, is an important concept in financial management. It can be used to compare investment alternatives and to solve problems involving loans, mortgages, leases, savings, and annuities. TVM is based on the concept that a dollar today is worth more than a dollar in the future. That is mainly because money held today can be invested and earn interest. A key concept of TVM is that a single sum of money or a series of equal, evenly-spaced payments or receipts promised in the future can be converted to an equivalent value today. Conversely, one can determine the value to which a single sum or a series of future payments will grow to at some future date. The time value of money serves as the foundation for all other notions in finance. It impacts business finance, consumer finance and government finance. Time value of money results from the concept of interest.

Key Components of Time Value of Money

Present Value is an amount today that is equivalent to a future payment, or series of payments, that has been discounted by an appropriate interest rate. The future amount can be a single sum that will be received at the end of the last period, as a series of equally-spaced payments (an annuity), or both. Since money has time value, the present value of a promised future amount is worth less the longer the waiting time to receive it.

PV = FV [1/(1+i) n]

FV = Future Value
PV = Present Value
i = the interest rate per period
n= the number of compounding periods

Future Value is the exact opposite of the present value. It is the amount of money that an investment with a fixed, compounded interest rate will grow to by some future date. The investment can be a single sum deposited at the beginning of the first period, a series of equally-spaced payments (an annuity), or both. Since money has time value, it is expected that the future value will be greater than...

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Block, S.B., & Hirt, G.A. (2005). Foundations of Financial Management (11th ed.).
[University of Phoenix e-text version]. New York, NY: McGraw-Hill Irwin.
Retrieved August 10, 2008, from University of Phoenix, e-campus website.
Stickney, Clyde P., and Weil, Roman L. (2000). Financial Accounting: An Introduction
to Concepts, Methods and Uses, 9th ed. Ft. Worth, TX: Dryden.
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