Time Value of Money (TVM)

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Introduction: Why Money Today is Worth More Than Tomorrow

Money has the power to grow over time. The Time Value of Money (TVM) is a financial concept that explains why ₹100 today is worth more than ₹100 in the future. The reason is simple: you can invest today’s money and earn interest on it.

For example, if you put ₹100 in a bank that offers 10% annual interest, after one year, you will have ₹110. In two years, this amount will grow to ₹121. This happens because the money is earning interest, and with time, interest is also earned on the previous interest.

Why is TVM Important?

TVM helps people and businesses make smart financial decisions. It is used for:

  • Saving for the future – Knowing how much your money will grow over time.
  • Investing wisely – Comparing different investment options.
  • Borrowing money – Understanding how much a loan will cost over time.
  • Business planning – Deciding if a project is worth investing in.

Key Ideas of TVM

There are two main ways to look at TVM:

  1. Present Value (PV) – How much a future amount of money is worth today.
  2. Future Value (FV) – How much your money today will be worth in the future.

Interest plays a big role in TVM. It can be:

  • Simple Interest – Earned only on the original amount.
  • Compound Interest – Earned on both the original amount and the interest already earned.
  • “The Time Value of Money is the concept that money available today is worth more than the same amount in the future because of its earning potential.”
    — Dr. Aswath Damodaran, a professor of finance at New York University.
  • “The Time Value of Money means that a dollar today is worth more than a dollar in the future due to the ability to earn a return on that money.”
    — Eugene F. Brigham and Michael C. Ehrhardt, from their book Financial Management: Theory & Practice.

Key Ideas of Time Value of Money:

  1. Present Value (PV): This is how much future money is worth in today’s terms. For example, if you expect to get ₹10,000 in the future, you can calculate how much that amount is worth today.
  2. Future Value (FV): This is how much your money today will grow into in the future if you invest it. For example, if you invest ₹5,000 today, the future value tells you how much that money will become after some time, with interest.
  3. Interest Rate (r): This is the rate at which your money grows. It can be simple or compound:
    • Simple Interest: You earn interest only on the original money you invested.
    • Compound Interest: You earn interest on both the original money and the interest that has been added over time. This helps money grow faster.
  4. Time Periods (n): The length of time (years, months, etc.) for which the money is invested or borrowed.

Simple Formulas:

Future Value Formula:

FV = PV × (1 + r)n

This formula shows how much your money today (PV) will be worth in the future (FV) after growing at a certain interest rate (r) over a certain number of years (n).

Present Value Formula:

PV = FV / (1 + r)n

This formula tells you how much future money (FV) is worth today (PV) when adjusted for the interest rate (r) over time (n).

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