T i m e v a l u e o f m

The time value of mone

y (TVM) is the concept
that money available at
the present time is wort
h more than the identic
al sum in the future due
to its potential earning
capacity. This core prin
ciple of finance holds th
z at, provided money can
earn interest, any amou
nt of money is worth m
ore the sooner it is rece
ived.

Made by
Karan bhatnagar
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Present Value and Future Value

Present Value is the same as Time Value as elaborate
d above. It is the money you have currently that is equ
al to a future one-time disbursal or several part-payme
nts – discounted by a suitable rate of interest.
Future Value is the sum of money that any saving sch
eme with a compounded interest will build to by a pre-
decided future date. It applies to both lumpsum as well
as recurring investments like SIP.
a can vary to some extent. Example, in the case of annuity (income
) or perpetuity
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(until death) pension payments, the general formula
can have more components. But as a whole, the basic TVM formul
a

FV = PV x [ 1 + (I/ N) ] (N*T)
Where,
FV is Future value of money,
PV is Present value of money,
I is the interest rate,
N is the number of compounding periods annually and
T is the number of years in the tenure.
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Five components of Time Value of Money
Based on the above examples, we can say that the compo
nents of any TVM problems or calculations are;
Tenure (The total number of compounding or discounting p
eriods)
Rate of Interest
Present Value (PV) or Today’s value
Future Value (FV)
The fifth component is Periodic Payments (Pmt) .
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Time Value of Money : Compounding & Discounting
The basic principles of TVM are compounding and discounting met
hods.
Compounding : When we hear the word ‘compounds’, the first thing
that comes to mind is GROWTH . That means we expect our invest
ment to grow and yield some return (or interest) .

Discounting : Compounding is about the future value of today’s inv

estment, where as discounting is the today’ value (PV) of money to
be received in the future (FV – Future Value). Present value is calc
ulated by applying a discount rate (opportunity cost) to the sums of
money to be received in the future.
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Specific variations of the time value of money calculations a
:
◆Net Present Value (lets you value a stream of future paym
nts
into one lump sum today, as you see in many lottery
payouts)
◆Present Value (tells you the current worth of a
future sum of money)
◆Future Value (gives you the future value of
cash that you have now )
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Determining the Time Value of money
1. Number of time periods involved (months, years)
2. Annual interest rate (or discount rate, depending on t
he calculation)
3. Present value (what you currently have in your pocke
t)
4. Payments (If any exist; if not, payments equal zero.)
5. Future value (The dollar amount you will receive in th
e future. A standard mortgage will have a zero future val
ue because it is paid off at the end of the term.)
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Application of time value of money principle
Time value of money is one of the most fundamental p
henomenon in finance. It is underlying theme embodie
s in financial concepts such as:
Net present value ,
Internal rate of return ,
Compound annual growth rate, etc.
It is the basis used to work out the intrinsic value of a fi
rm, a share of common stock, a bond or any other fina
ncial instrument.
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Time value of money relationships
In any time value of money relationship, there are followi
ng components:
A value today called present value (PV),
A value at some future date called future value (FV),
Number of time periods between the PV and FV, referre
d to as n,
Annual percentage interest rate labeled as r,
Number of compounding periods per year, m,
An annuity payment (only case of annuities), PMT.
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Important:-
Time Value of Money is important in fin
ancial management. TVM can be used t
o compare different investment options
and to solve problems involving mortga
ges, leases, loans, savings and annuitie
s.