Time Value of Money

Money received today is more valuable than the same amount of money a year from now. It is important to understand the relation of money and time since the value of money is affected by time through Inflation and Loss of Opportunity. Money loses its purchasing power over time due to inflation. As prices rises the same amount of money today won't be able to purchase the same number of goods a year from now. Another way you lose money over time is through loss of opportunity. Money that should have been received a year ago could have earned if it were invested a year ago.

In order to determine the value of money over time we will use the formula below.

PV = Present Value
FV = Future Value
IR  = Interest Rate
N   = Number of Years

PV = FV / (1+IR)N



Effect of Inflation on Value of Money.

"A million today is worth more than a million ten years from now." In order to understand how much value or purchasing power is lost over time we will compute the present value of a million ten years from now. We will assume that inflation rate will be at 4% annually. Using the formula above we will substitute the interest rate with inflation rate.

Sample:

FV =1000000
IR =4% or .04
N =10 Years
PV =1,000,000 / (1+.04)10
=1,000,000 / 1.4802
=675,564.17

How much will your Investment be Worth in the Future?

"Let your money work for you."
The longer your money is invested the better the chance for it to grow. Whether you put it in a savings account, fixed income securities or in stocks, with enough time it can earn huge returns. The earnings earned from your investment will in turn earn money. In order to determine how much an investment could earn for a particular period we will use the Future Value Formula. Using the future value formula will allow you to estimate the returns of your investment. You can compute Future Value of your money using the formula below.
PV=Present Value
IR=Interest Rate
N=Number of Years
FV =PV x (1+0.10)N

How much will one hundred thousand be worth if you invested it in equities with an average return of ten percent a year for the next ten years? How much will be the Present Value of your investment ten years from now if inflation rate is at 4 percent per year?


PV=100,000
IR=10% or .10
N=10 Years
FV=100,000 x (1+0.10)10
=100,000 x 2.5937425
=259,374.25

PV=259,374.25 / (1+0.04)10
=259,374.25 / 1.480244285
=175,223.95