Time Value of Money

What is Time Value of Money (TVM)?

Time value of money is a concept or an idea that money at present time is worth more than in the future time. So if you now have $100, it is worth more than if you have $100 in three years from now. This concept is the core principle in finance study. Why it is worth more now? Because you can use the $100 to generate more earning now. The image below shows us simple view about this TVM concept.

source: investopedia

The option A, you have $10,000 in this time (now, Year-0). You can deposit it in the Bank to gain interest later. Talking about how much your money worth in the future, we talk about the future value of money. Then how do you know how much your money worth in the next three years? We use formula describe below:

FV = PMT x FVIF

where
FV = future value of money
PMT = the payment
FVIF = future value interest factor

Then what is FVIF? FVIF is a factor utilized to determine the future value of dollar amount you have now. The formula is:

FVIF = (1 + i)n

where
i = interest rate
n = number of years (frequencies of payment)

So, let’s calculate how much money you will earn in three years from now by saving $10,000 with interest 10%?

FV = PMT x FVIF
FV = $10,000 x (1 + 0,10)^3
FV = $10,000 x 1.331
FV = $13,310

The option B, you have $10.000 in three years from now (Year-3). You want to have $10,000 three years from now then how much you have to save to get it? We use formula describe below:

PV = PMT x FVIF

where
PV = present value of money
PMT = the payment
PVIF = present value interest factor

Then what is PVIF? PVIF is a factor utilized to determine the present value of dollar amount to be received in the the future. The formula is:

PVIF = 1/((1 + i)n)

where
i = interest rate
n = number of years (frequencies of payment)

So, let’s calculate how much your money worth now if you will earn $10,000 in three years from now with interest 10%?

PV = PMT x PVIF
PV = $10,000 x 1/((1 + 0,10)^3)
PV = $10,000 x 0.7513
PV = $7,513

So, if you have $10,000 now, it will be worth now rather than earn it three years from now because the money will worth only $7,513 now assuming the interest rate is 10%.