Time value of money
From Wikinfo
The time value of money is one of the basic concepts of finance. Time value of money is the change in consumption power of money over time. $100 today can consume more than $100 in 5 years. It also takes into account some risk. $100 today is a sure thing and can be enjoyed now. In 5 years that money could be worthless or not returned to the investor. This is where the interest rate inherent in TVM comes from.
A hundred dollars invested today at 5% per year interest rate will yield
- <math>{\rm present\ amount}\times(1+{\rm interest\ rate})^{\rm term}=\$100\times{(1+.05)^1}=\$105</math>
in 1 year. So the future value of $100 in 1 year at 5% per year is $105
A hundred dollars 1 year from now at 5% interest rate is today worth:
- <math>\frac{\rm present\ amount}{(1+{\rm interest\ rate})^{\rm term}}=\frac{\$100}{1.05}=\$95.23.</math>
So the present value of $100 1 year from now at 5% is $95.23
See also: Time preference theory of interest
References
- Adapted from the Wikipedia article, "Time_value_of_money" http://en.wikipedia.org/wiki/Time_value_of_money, used under the GNU Free Documentation License
