Time Value of Money (TVM)

Time value of money is the concept that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. In its simplest form, the time value of money is essentially a present value or future value calculation, and can be expressed by the formula PV = FV/(1+r)^n where “PV” represents present value, “FV” represents future value, “i” represents the investor’s reinvestment rate, or the rate of return they could earn on another investment, and “n” represents the number of periods until the future value is received.

For example, if an investor will receive $1,000 six years from today and believes they could earn 8.0% by investing elsewhere, then applying the time value of money concept, the investor would need to purchase the investment for $630.17 or less ($1,000 future value divided by one plus 8.0% to the sixth power). This can also be thought of as the amount that needs to be invested today in order to have $1,000 six years from now, assuming the investor can earn an 8.0% return on the investment. Time value of money calculations can become more complex as additional variables are added such changing cash flows or interest rates or number of times per year interest is compounded. See also compounding and discount rate.

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