Basics

The time value of money is an economic concept that accounts for the difference in value a certain sum of money has based on the time involved in gaining or losing it. In essence, the time value of money is a way of acknowledging the difference between being paid today and being paid at some future time, requiring a wait. For most people, waiting for money is much less desirable than having it immediately. This is because waiting involves the potential for an opportunity cost.

Present Vs. Future Value

The time value of money is usually expressed as the difference between the present value of a sum of money and that same sums future value. The present value is usually the outright value of the money, if paid immediately, while the future value is the amount of money plus interest. This is because receiving the same amount money in the future means the loss of an opportunity to earn interest.

Use in Capital Budgeting

References

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