Chapter 2

Key Financial
Concepts:
Time Value of Money

Dr. Wolfgang Messner

https://www.amazon.com/Making-Compelling-Business-
Case-Decision-Making/dp/1137340568/ref=sr_1_1
 Someone offers you money.
Which option do you take?

£ 87
today
£ 100
in 2 years
time
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Time value of money

A dollar today is worth more than a dollar

tomorrow

Why?
▪ Today’s dollar can be invested to start earning interest immediately
▪ Tomorrow’s dollar can only be invested tomorrow

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Future value

Invest $500,000 in securities at 5% p.a.

What do we get a year from now?

Rate of return

$500,000 ∗ 1.05 = $525,000

Present value Future value

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Future value

What do we get two years from now?

Rate of return

$525,000 ∗ 1.05 = $551,250

Future value Future value

(1 year from (2 years from
now) now)

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Future value (n years from now)

What do we get n years from now?

Rate of return

𝑛
𝐹𝑉 = 𝑥 ∙ 1 + 𝑟

years
Present value

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Compound interest

▪ When interest is earned on interest, period after period

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Effect of compound interest

Time until
Interest
doubling
rate r
= 2

0.50% 139.0 years

1.00% 69.7 years
1.50% 46.6 years
2.00% 35.0 years
3.00% 23.4 years
4.00% 17.7 years
5.00% 14.2 years
7.50% 9.6 years
10.00% 7.3 years
15.00% 5.0 years
20.00% 3.8 years
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Present value

▪ We already know the likely future payoff C

▪ What is its present value?

Expected
payoff a year
from now

1
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑃𝑉 = 𝐶 ∗
1+𝑟

Discount factor

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Present value

▪ If cash flow C takes place two years from now

1
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑃𝑉 = 𝐶2 ∗ 2
1+𝑟

▪ If cash flow C takes place t years from now

1
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑃𝑉 = 𝐶𝑡 ∗ 𝑡
1+𝑟

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Discount rate r

▪ The interest rate used in discounting future cash flows

▪ Also called
- Hurdle rate

- Internal rate of return

- Opportunity cost of capital

- …

▪ Provided by the organization’s financial management

▪ Typical discount rate is somewhere between 5% and 15%

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Time value of money in business cases

▪ Used to understand the additional return offered by an investment

proposition as compared to putting the same money in government
securities
▪ If the investment proposition offers less than the prevalent interest rate in
government securities, it’s better to stay away from it

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Thank you for your attention!

Wolfgang Messner
Dr. rer. pol. (Univ. Kassel), MBA (Univ. of Wales), Dipl.-Inform. (Techn. Univ. Munich)

Clinical Professor

wolfgang.messner@moore.sc.edu

www.wolfgangmessner.com | moore.sc.edu

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