All about Time Value of Money (TVM)

What Is the Time Value of Money (TVM)?

The Time Value of Money refers to the idea that a sum of money today holds more value than the same amount in the future. Why? Because money has the potential to grow over time through investments. In other words, a ₹1 in hand today is worth more than a ₹1 promised at a later date.

Understanding Time Value of Money

Investors prefer immediate cash over the same amount in the future because invested money grows over time. For instance, depositing money in a savings account earns interest. Over time, interest accumulates, enhancing the principal amount. This phenomenon, known as compounding interest, demonstrates the power of TVM.

Time Value of Money Formula

The fundamental TVM formula considers several components:

• Future Value (FV): The value of money at a future date. of the passive fund. Over long investment horizons, lower costs may result in considerably higher returns due to the compounding effect.
• Present Value (PV): The current value of money.
• Interest Rate (i): The rate at which money grows.
• Number of Compounding Periods per Year (n): Determines how often interest is compounded.
• Number of Years (t): The time duration.

  The TVM formula is expressed as:

  FV = PV /(1 + (i/n))^n*t

Key Components of TVM

Remember these three components:

ETFs versus Index Funds – Price

• PV: Present value (current worth).
• FV: Future value (anticipated worth).
• Discount Rate: The rate used to discount future cash flows to their present value.

Examples of Time Value of Money

Suppose you invest ₹10,000 for one year at a 10% interest rate compounded annually.

Let’s calculate the future value using the TVM formula:

1. Present Value (PV): ₹10,000

2. Interest Rate (i): 1. 10% (expressed as 0.10)

3. Number of Compounding Periods per Year (n): 1 (since it’s compounded annually)

4. Number of Years (t): 1

Using the TVM formula:

FV=PV/(1+(i/n))^n×t

Substituting the values:

FV=₹10,000(1+0.1)^1

Calculating:

FV=₹10,000×1.10=₹11,000

The future value of your investment after one year would be ₹11,000.

The above example is for illustrative purpose only.

Why is Time Value Money (TVM) Important?

• Investment Decisions: TVM guides us in choosing between immediate cash and future payments. It emphasizes that a delayed investment may be a lost opportunity.
• Compounding: TVM highlights the compounding effect, where interest on interest accelerates wealth accumulation.
• Inflation Impact: TVM accounts for inflation, ensuring we consider the eroding purchasing power of money over time.

Importance in Finance

Understanding TVM is vital for financial decision-making. It bridges the gap between present and future values, helping us make informed choices. Whether it’s capital budgeting, personal finance, or investment analysis, TVM plays a pivotal role.

TVM and Investment Analysis

Investment decisions involve assessing the present value of expected future cash flows. TVM helps evaluate investment opportunities, considering risk, return, and time.

Impact of Interest Rates

Interest rates directly affect TVM calculations. Higher rates accelerate growth, while lower rates reduce it.

In summary, understanding TVM empowers us to make informed financial choices with an aim to optimize investments.

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