Understanding The Time Value of Money

If you were given A- $10,000 now OR B- $10,000 in three years, which option would you choose? The answer all depends on the time value of money

What is time value of money?

A dollar today is worth more than a dollar in the future, because the dollar received today can earn interest up until the time the future dollar is received. The answer for the above question is A because by receiving $10,000 now, you could invest and earn the interest. So the future value of the money for option A is $10,000+ interest. On the other hand, the future value of money for option B is just $10,000.

Future Value Basics

Future Value= Original Amount x (1+interest rate par period)^number of periods

Present Value Basics

Present Value= Future Value/(1+interest rate par period)^number of periods

As you now realized that time is money, you have to consider the Future value of money when you invest. It is important to calculate the future value of money to compare investments that offer you at different time periods.