Understanding the Concept of the Time Value of Money
The time value of money is a vast concept that explains money’s worth. It refers to the idea that your money right now is worth more than your future. This principle is based on the formula enabling the investors to know insight into the value of money for its future worth. This concept has significance in terms of how time affects the value of money.
For example, one million rupees could be of more worth than now. You might have purchased the property for 1 million rupees; after a decade, its value has increased to 1.5 million.
Determining this difference in the worth, the formula of the time value of money helps in figuring out the cost worth later. When you invest somewhere, inflation can cause loss sometimes. There is no certainty that if you invest somewhere and believe it to yield an annual interest of 5%, it’ll help you tackle inflation of the present and project high-interest rates.
Money changes with time. It’ll be best if you calculate the time value of money to ensure investments are worth it.
Examples to Understand the Concept
- Parents Complaining about Prices: Have you ever heard your parents say in our childhood, we used to buy this candy for 2 rupees, and now it is 5 rupees or something? In our time, things were relatively inexpensive. Your parents explain the concept we are trying to convey — money’s time value changes with time. The property you purchased a year back now has more worth.
- Taking Money from a Friend: Imagine you had lent 5 lac rupees to your friend. He is saying to pay you the exact amount immediately or 5.25 lac rupees a year later. You have a better chance of earning 12% interest if you invest 5 lac rupees.
- What should you do? You should take your money immediately from your friend and invest in the new offer. You can get more interest and revenue in this investment than your friend.
3. Purchasing and Selling Property: Consider you purchased a plot with this money, but if you take it a year later, the price of that plot might have increased. If the property was of 10 lac rupees and you are getting 1 lac extra after a year means 10% revenue.
- Is it making sense? Being offered and getting money today is better than getting it later. Today’s money is more valuable than money received in the past.
The Formula for Time Value of Money
- The money you have right now is the present value (PV).
- The money worth after a specified period is the future value (FV).
- The rate at the PV increases per year is the Interest rate (I).
The formula for the time value of money becomes:
- Future value = (Present value) x (1 + interest rate) ^ Number of periods
- FV = (PV) x (1 + I) ^ Number of periods
The formula helps people figure out how much money will earn in the future. Understanding the effect of inflation cashmere and why early investment can beat inflation is essential.
Conclusion
Every person and company have financial goals and requirements. Setting manageable targets after defining these priorities helps you to consider these goals from a financial standpoint. The time value of money shows that the money you have now differs from the money you will have in the future. When deciding between the prices of assets that yield returns at different times, you factor in the significance of the time value of money.
