Question

Explain the time value of money. Include definitions of terms such as present value and future value. Give an example of time value of money in real life.

Answer 1

• The concept, time value of money states that a sum of money in present is much more worth than its value in future.
• This is because any amount received in future will have interest Associated with it. Hence a person receiving the same amount of money in present will benefit more than he would benefit in future.
• Therefore the time value of money in present is said to be much more worth in present than in future.

Present value and future value

• Present value refers to the current value of a future sum of money while future value refers to value of any sum of momem in future given its interest rate accumulation and rate of growth.

Real life example of time value of money :

A person wants to purchase a refrigerator of $20,000 from a shopping mall and hence asks the salesman about the payment process. The salesman presents him with two options :

a. Either pay the full amount of $20,000 and get a discount of 2000 with ready cash.

OR

b. Pay full amount of 20,000 through installments for 30 month's at an interest rate of 4%.

According to the concept of time value of money, it would be better if he chooses option A as he just have to pay 18,000 after discount.

If he chooses option B, the person has to pay $6,172 for 30 months and pay the full amount of 20,000.