Concept of Time Value of Money


Everybody knows that money placed in a savings account will earn interest. Because of this worldwide fact, we would desire to obtain money today rather than the same amount in the future.

We can use TVM to compare the worth of cash flows occurring at different times in the future, to get the amount of current investment that must be made at a given interest rate. Time value of money principle also applies when comparing the worth of money to be received in future and in further future.  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.

The Time Value of Money does not make you “guarded” in the real world of investing. Commercial bank deposits and Government Sponsored Enterprises are including in Low Risk Investment. Corporate bonds that are rated investment grade and Blue Chip U.S. stocks, including many of the companies, are included in Medium Risk Investment.

Default risk arises when the borrower does not pay the money back to the lender. Inflation is the rise in general level of prices.

The Time Value of Money also gives some powerful advantages for patient investors. The Time Value of Money has applications in many areas of Corporate Finance including Capital Budgeting, Bond and Stock Valuation.

The Time Value of Money is divided in two parts: Future Value and Present Value. Present value of a single sum of money, present value of annuity, future value of a single sum of money, future value of annuity, simple and compound interest are included in the Time Value of Money. Future Value defines today’s investment process, which will grow in the future. Present Value defines determining future process of cash flow in today’s dollars.

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