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The time value of money is the value of money figuring in given amount of interest earned over a given period or amount of time. The time value of money is the essential concept in finance theory.
For instance, $200 of today’s money invested for one year and earning 10% interest will be worth $220 after one year. Therefore, $200 paid now or $220 paid exactly one year from now both have the equal value to the recipient who presumes 10% interest; By time value of money terminology, $200 invested for one year at 10% interest has a future value of $220.
All the standard calculations for time value of money obtain from the most basic algebraic expression for the present value of a future sum, “discounted” to the present by an amount equivalent to the time value of money. For instance, a sum of FV to be received in one year is discounted at the rate of interest r to give a sum of PV (at present): PV = FV − r·PV = FV/(1+r).
Several standard calculations based on the time value of money are:
- Present value – The current worth of a specified future sum of money.
- Present value of an annuity – An annuity is a series of equivalent payments or receipts that take place at evenly spaced intervals. Rental payments and Leases are examples.
- Present value of perpetuity – is an infinite and constant stream of similar cash flows.
- Future value – is the value of an asset or cash in the future that is equal in value to a specified sum today.
- Future value of an annuity (FVA) – is the future value of a series of payments.