Time value of money

If you are choosing Option A, your future value will be $10,000 plus any interest
acquired over the three years. The future value for Option B, on the other hand, would
only be $10,000. So how can you calculate exactly how much more Option A is worth,
compared to Option B? Let's take a look.

Under the time value of money (TVM) concept, a dollar received today is worth more
than a dollar received at a later date — which is one of the most fundamental concepts
in corporate finance.

In short, receiving money today is preferable (i.e. more valuable) than receiving the
same amount of money on a later date.

There are two main reasons that underpin the TVM theory:

1. Opportunity Cost: If you have capital on hand currently, the funds could be
used to invest into other projects to achieve a higher return — i.e. the
“opportunity cost” of the money.
2. Inflation: There are risks to consider such as inflation or the probability that the
company in question might go bankrupt in the future — i.e. future uncertainty
should be costlier than the lower risks identified on the present date.

The time value of money concept is all about how money is worth more now than in the
future because of its potential growth and earning power.

Here’s more about the concept, how to calculate the time value of money and why it
might be an important tool for financial decision making.

The time value of money is the concept that money is worth more in the present than in
the future due to its potential earning capacity, or alternatively, to inflation. If you invest
$100 today, that money can start earning interest or dividends. In the future, your initial
investment will be worth more than $100 due to the earnings on that investment. In this
way, money can be said to have a time value.
The future value of money is the amount of money you’ll have in the future, assuming
you invest a specific amount of money in an account with a certain interest rate.
Investors can use this calculation to compare different investments, such as a high-yield
savings account versus stocks. The math can become tricky because it’s based on the
assumption of stable growth. For accounts with a set interest rate and one, up-front
payment, the formula is simpler, as you can see from the above example.