The “Time Value of Money” is the concept that money available at the present time is worth more in the future due to its potential earning capacity. This core principle of finance holds that provided money can earn interest.
Given that money can earn compound interest, it is more valuable in the future.
The formula for computing time value of money considers the payment now, the future value, the interest rate, and the time frame.
The number of compounding periods during each time frame is an important determinant in the time value of money formula as well.
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Time Value of Money Formula
Depending on the exact situation in question, the time value of money formula may change slightly. For example, in the case of annuity or perpetuity payments, the generalized formula has additional or less factors. But in general, the most fundamental TVM formula takes into account the following variables:
FV = Future value of money
PV = Present value of money
i = interest rate
n = number of compounding periods per year
t = number of years
Based on these variables, the formula for TVM is:
FV = PV x [ 1 + (i / n) ] (n x t)
Time Value of Money Examples
Assume a sum of $10,000 is invested for one year at 10% interest. The future value of that money is:
FV = $10,000 x (1 + (10% / 1) ^ (1 x 1) = $11,000