Understanding Time Value of Money (TVM)
What is Time Value of Money?
The Time Value of Money (TVM) is a fundamental financial concept that states a dollar today is worth more than a dollar in the future due to its potential earning capacity. This core principle of finance holds that any amount of money is worth more the sooner it is received.
Key Components
TVM calculations involve five key variables:
- Present Value (PV): The current value of money
- Future Value (FV): The value of money at a specific point in the future
- Interest Rate (r): The rate of return or growth rate
- Time Periods (t): The number of periods money is invested
- Compounding Frequency (n): How often interest is calculated and added
Practical Applications
TVM is crucial for:
- Investment decisions
- Retirement planning
- Loan calculations
- Business project evaluation
- Real estate investment analysis