Question

In finance, what do we mean by the time value of money? How do we calculate it?

Answer 1

Step 1

 

• The Time value of money is a concept that says the amount of money has more worth in the present time than in the future with the same amount of money due to its potential earning capacity.

 

• Money loses its value because of inflation, which reduces the buying power of money.

 

• Suppose today you are having $100, its present value is also $100 but its future value will be $97.56 discounted at an inflation rate of @2.5%.

 

• For this reason, the future value is worth less than the present value.

Step 2

Following are the formulas for future value and present value:

• Future value=PV(1+r)nPV = present valuer = interest raten = years Future value=PV(1+r)nPV = present valuer = interest raten = years 

 

• Present value = FV(1+r)nFV=future value, r = interest rate, n=years

FV=future value, r = interest rate, n=years