Question

What is the time value of money?

Answer 1

Money takes on a different value in different time periods.

Explanation:

As the saying goes: "a dollar today is not the same as a dollar tomorrow." But why? Let's look at two different scenarios.

1. The dollar is put in a sock drawer and taken out 10 years later. Will it buy in ten years what it buys today? Probably not because of inflation which generally increases the price of goods over time. (Yes, there are some exceptions.) Ten years ago, the price of my local newspaper used to be $1, Today it costs $1.50. So in terms of what it can buy, my $1 buys less. It is worth less. It will have a different value in 10 years.

2. The dollar is invested in a savings account. Even though interest rates are low today, the $1 should have grown to a greater sum 10 years later. In time value language, it's future value will be greater than $1. The mathematics of time value can calculate just how much it will be worth.