Understanding Time Value of Money

The concept of time value of money (TVM) emphasizes that a dollar today is worth more than a dollar tomorrow due to factors such as inflation, interest rates, and the possibility of earning returns on investments. TVM can be applied in various financial contexts, including bond calculation, electronic monthly installments, loan calculations, real estate investment, and compounding/discounting methods. It highlights the importance of investing early and taking calculated risks to generate higher returns, as opposed to leaving money idle or subject to inflationary erosion. The concept also underscores the significance of understanding the impact of leverage and diversification on investment returns.

The time value of money indicates stipulated that money earned today will be more than its
intrinsic value when we become more specific we can say that the money we have right now
could be worth more than in the future than today. In personal finance, the risk and the return are
the concepts that each boils to a pretty simple statement. This two concept expect a dollar risked
to high return than a dollar.
This blog contains the concept describing the time value of money and how should you use it?
For investment in finance, the time value of money is essential. This concept helps to understand
why interest rate has paid or earned on deposit or the debt, compensate the parties based on the
time value of money.
What time value of money is?
The time value of money is an integral area in the field of finance. Money is the determinant of
present and worth than tomorrow's future value of money as it involves opportunity cost waiting.
The time value of money is related to the concept of inflation and purchasing power, the value of
money fluctuates and gradually erodes its purchasing power and value. When you using your
money to lend or to invest you certainly expect higher returns. The aim is to maximizing
compensation without that money for a short time. Money has time value let us take the example
of the money you have today is more value in the future than it will be in two or three years.
With the time money has large potential. The earning capacity of the amount of money will be
more than the intrinsic value. The time value of money is also known as the present discounted
value. You deposited money into a savings bank account and earns an interest rate to compensate
for without keeping the money at the current period. If a bank holder deposits $ 200 in the
account, he expects to receive more after one year than $ 200.
There are reasons for the time value of money. In an uncertain future, one can control the
spending but not control the income or the inflows. Everybody wants to avoid risk and prefer
cash receipts nowadays. Reason inflation, the economic trend defines inflation. The money you
received now is more useful than the money you received in the future. The last reason is the

attached interest factor when the particular amount of money is received and paid after some
time. The values in the present and future are different. People invest their income in the hope of
higher returns in the future. This factor helps to consider the dilemma of uncertainty that cash
flows don't have any uncertain thing. The concept of present value and future value calculation
solve the corporate world's financial management that is related to capital budgeting, investment
decisions, etc.
If you are smart, you should use the money to create more from that, this can provide high
opportunity. It is based on the investment plan where you invest your money. The opportunity
cost can compare the plans. The yield rate determines the returns you get. The time value of
money states that money has large potential and. If simply said the value is more than tomorrow.
The efficient way of lending money is that the person agrees to take the risk and higher
purchasing power.
The opportunity cost for each choice you made there are choices sacrificed. The choice to go for
education to college is an easy example of opportunity cost. The choice in between you are
giving up 5 years worth of your salary you would have generated at a job and 5 years of work
experience that is the future payment.
Straight forward you hope that by investing in property, you will make more money in the future
over your lifetime than if you don't go college and attend. Its type of gambling can calculate
hopefully has an additional significant pay off finally than you had opted to not go to college.
This shows that the time value of money varies proportionately and includes an opportunity cost.
That clarifies if you are putting your investment of $ 2000 in a saving account to save for future
to purchase property, you may be forecasted an opportunity to be increasing that money is an
investment account. For example, the calculation of time value of money tells you that rather
than investing you should be paid down the debt that cost you more up to hundreds per month.
How you should use the time value of money?

Money has time value let us take the example of the money you have today is more value in the
future than it will be in two or three years. You lend money to your friend. You can determine
more earning if you lend money and he repays you at present $ 4000 or $4100 later. You can opt
for this opportunity to invest somewhere other than that of late payment. There are other time
preferences you receive the payment presently or wait. This is the reason for the importance of
the present value of money. It is more worth than the future value of money.
Another example of the time value of money consideration for a longer period. If the money
repaid you after 45 years . to justify this factor
Purchasing power- the exchange of money can take place for goods and services. For instance
many years ago the rupee has a huge value than the present.
Risk and return- the risk of getting back the money are associated with the lending amount. The
default risk contains whether you may or may not get back your own money. That's why the
more compensation you expect in return.
For example If your lending money to a person who goes bankrupt or insolvent, you lose your
money.
If you're considering yourself as an individual or for a business decision, we can use the example
of how to apply the time value of money. To measure the time value of money the formula of
present value applies by using compound interest rate.
Future value = present value (1 +(i/n) (n×t)
For the use of the time value of money, it is important to understand the present value and future
value of money.
The present value of money

The money has today show the present value. After deducting the interest and the future
payments you will determine the present value.
Calculation of present value of money :
For example, Sally has $ 20,000 at present, after six years how much that $ 20,000 worth.
If you made the investment that can produce 7% of compound interest annually. N= 6 year
Payment- $ 20,000 present value=?
The calculation of future value $ 28051.
Net present value
Net present value is the difference between the total present value of all the future cash flows
that is cash inflows and cash outflows.
The concept uses the time value of money and uses the NPV function to discount the company’s
weighted average cost of capital. For the identification of stock, valuation DCF helps whether
the stock is overvalued or undervalued. This is an important decision making in investment
structure rather. Discounted cash flow predicts future cash flows. It is normally convenient for
big firm’s financial working; the growth and the financial working have a steady move.
The given formula can be expressed as:
Discounted cash flow: CF1/( 1+r ) 1 + CF2/ ( 1+r ) 2
+ CFn/ ( 1+r )n
CF1 = cash flow at the end of year
r = discounted rate of return
n = life of the project

To calculate NPV, assuming the cost of capital is known. It is based on the positive and negative
aspects, it becomes positive we should keep further proceeds and if it becomes negative,
investment should be made.
NPV = Cash flows present value – Cash outflows present value
Year 0 1 2 3 4
Cash
Flow 2,00,000 40,000 40,000 30,000 40,000
The initial cash flow= INR 2, 00,000 for the incorporation of the project.
2, 00,000= 40,000 / (1+r) + 40,000/ ( 1+r ) 2 + 30,000( 1+r ) 3 + (40,000)
On computation r= 17.37%. However, if the rate of return is expected higher than 17.37
%, then the project should be accepted otherwise should be rejected.
Future value

The invested money will receive at a future specified time. This money you get with
enhancements, this amount you will get with the principal and interest rate. The money worth
more in the future that you invested today.
Time value of money- key drivers
Five major components are using in the calculation of time value of money
Year- N denotes the number of years, represents the period of your investment. According to the
duration of investment, the time value of money changes.
Interest rate- The interest rate represents the growth of your money. Interest is what you obtain
over some time or paying someone over the time that money held.
Payment - it represents the period of payment. The period of payment to be received or paid
overtime. When you receive your payment it shows the positive value. In case if you make
payments it shows negative value.
The series of equal cash flows, you can calculate the fourth variable if you are given any four
variables in cash flow. For example, if you invest $ 2 present value for only one year at the rate
of 5% you will receive $ 2.1 future value. This would be similar to say the present value of $ $
2.1 you expect to receive in one year, is only $ 2.00 present value.
You can use the time value of money rather than considering the amount compared to the total
installments. First, you should determine the value of money and then go for the comparison.
The application of time value of money in the financial field
Bond calculation

A bond has an interest rate of 5% and pays $ 8,000 after the expiry in 6 years. The simple way to
calculate the present value of future cash flows included coupon payment and the amount of
principal. This is to compare it with the sum for today's judgment, even in the case, these bonds
make any sense or not.
Electronic monthly installment
We can you the time value of money to determine the monthly installments. This can be done
which you finally pay along with the interest.
loan
The amount of down payment and how much amount can be financed for the loan, it helps in
determining such plans. This is also used in credit card and mortgages calculation etc. each type
of loan issue can be solved with the help of the better calculation of the time value of money. For
example: if one of the people is interested to give interest in his salary. Suppose he has no source
of other income because he is taking the big amount of loan . his job is also not secured like
government jobs. Because of these reasons, you can opt to give a loan to him due to the time
value of money. Your money will increase without the involved risk because many banks give
you the security of the interest and also your money. Many businesses give the assets by taking
the cash and the assets will give you the best profits. The reason is inflation that the value of the
assets will rise and you will sell the assets in scrap, you will cover all the loss.
Real estate and leverage
In the stock exchange, you use your money to control the investment. While in real estate you
require twenty percentage to control your whole property. When you sell and generate monthly
income on that particular property, that means your money is on the full value of the investment.
The returns are multiplied.
To understand the impact of leverage and how it works with the time value of money. The
different examples of people who have $ 50,000 to invest in the real state.
Annie invests $ 50,000 after deducting taxes, insurance charges, property management fees, the
property generated a cash flow of $ 250 per month.

At the annual end, Annie will have made $ $ 3,000 a 6% return on investment is not bad.
Mason took the same amount of money $ 50,000, rather putting all the investment in one
property he invested $ 10000 into several five properties investment. After the treatment of taxes,
insurance, the property generated a cash flow of $ 150 per month per house.
At the annual end, a mason will have made $6000 a 12% return on investment is not bad. The
returns are double than the similar $ 50,000 of the initial investment.
Here in this above case both the person Annie and mason where mason earns more than the
Annie but Annie also control $ 2,50,000 worth of a real estate. That of only $ 5,000 that means
more opportunities for the appreciation of home value and also low risk where mason is better in
diversified its investment in five renters.
Why TMV is important?
These are the concepts based on each recommendation.
Its always better to invest prior because of the time value of money concept. Each of the dollars
you invest today has a growth. the reason behind the investment of dollar is important than
sitting on it it doesn’t grow and catch up inflation, you will lose the purchasing power of money
over the period. The various factors of food, gas cost less and $ 40,000 salary used in these items
mean a lot to spend. The investment that promises a high return? It generates new risk also, or it
would have been snapped up already.
This investment decision doesn't mean bad decisions, we just need to understand what you re
getting in. there is risk involved for the invested money to catch up inflation o just be assure
yourself that you are comfortable with the taking amount. It doesn’t necessary to mean
Compounding and discounting
The methods are compounding and discounting in time value of money are:
The compound is a word related to growth. The motive or the aim is to expect high returns for
the particular investment. To yield returns or interest, there is no point in investing if the growth

rate is not more than the rate of inflation. You should be better off spending today when it has a
higher value. That's what the compounding or compound interest rate comes to save.
$ 4000 invested at present in a fixed deposit for 6 years can fetch. so is the interest accumulate
and interest on the interest.
Discounting: compounding explains the future value of today's investment. We discounting the
value of today's amount to be obtained in the future. The computation of the present value
applied discount rate means opportunity cost to the total amount of money to be obtained in the
future.
For example, $ 4000 invested at present in a fixed deposit for 6 years can fetch. so is the interest
accumulate and interest on the interest.