Time value of money

Definition

Time value of money (TVM) is the concept that money available now is worth more than the same amount in the future due to its potential earning capacity. This principle underpins many capital budgeting decisions and financial calculations.

5 Must Know Facts For Your Next Test

1. The present value (PV) formula discounts future cash flows to their value today using a specific discount rate.
2. Future value (FV) calculates what a sum of money today will grow to over a period at a given interest rate.
3. Annuities involve calculating either the PV or FV of a series of equal payments made at regular intervals.
4. The discount rate reflects the opportunity cost, risk, and inflation affecting the value of money over time.
5. Net Present Value (NPV) uses TVM to evaluate investment opportunities by comparing the present value of cash inflows and outflows.

Review Questions

• What is the formula for calculating present value?
• Why is $1 today worth more than $1 in the future?
• How does an annuity differ from a lump sum in terms of TVM calculations?

Related terms

Present Value: The current value of a future sum of money or stream of cash flows given a specified rate of return.

Future Value: The amount an investment is worth after one or more periods, calculated using compound interest.

Discount Rate: The interest rate used to determine the present value of future cash flows.