Time Value of Money (TVM)
The Time Value of Money (TVM) is a financial principle that states that a sum of Money has a different value today than it will in the future due to its potential earning capacity. This concept is grounded in the idea that Money can earn interest, and therefore, any amount of Money is worth more the sooner it is received.
Essentially, the value of Money changes over time due to factors such as inflation, Interest Rates, and Opportunity Cost. This principle is critical in various financial decisions, including investment analysis, loan calculations, and savings strategies.
Examples:
- Example 1: If you invest $1,000 today at an annual Interest Rate of 5%, in one year, it will grow to $1,050. Thus, the Money today is more valuable than the same amount in the future.
- Example 2: If you have the option to receive $10,000 today or $10,000 in five years, the $10,000 today is more valuable because you could invest it and earn interest over the five years.
Cases:
- Investment Decisions: Investors use TVM to evaluate the potential future earnings of investments, helping them choose where to allocate their funds.
- Loan Calculations: Lenders apply TVM to determine the present value of future loan payments, influencing Interest Rates and loan terms.