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The Benefits of Using the Time Value of Money
Imane Iraqi
Supervised by:
Professor Haitham Nobanee
Time Value of money relates to the idea that the money we own today doesn’t have the
same value as the same quantity of money in the future. In reality, the money we possess today is
worth more than the same amount of money we own after a year or more. Rational investors would
prefer to receive a certain amount of money today, instead of receiving the same amount of money
later on in the future, as they could invest it and earn interest on it. (Investopedia, 2020)
In finance, the time value of money is represented in the following formula: FV = PV x (1+I)^N
The FV refers to the future value, while the PV symbolizes the present value; I is the
interest rate or rate of growth, N represents the number of compounding years, and finally, T is the
number of years. In more detail, the Future value dictates what a cash flow earned in the present
would be worth later on, depending on interest percentages or capital profits. If it were invested at
a specific percentage of return and in a particular amount of time, it would measure the worth of
the present cash flow in the future. On the other hand, the present value expresses the value of the
cash flows made in the future in terms of today's money. It discounts the cash flows made in the
futire back to the present time, using the rate of return and duration of time. (Brightscape, Inc.,
2019)
The importance of time value of money lies in that money earned today is worth more than
the money being achieved in the future due to inflation, taking into consideration that if you earn
money today you can earn interest on it. Additionally, receiving your money today, instead of in
the future reduces the default risk, which is the risk associated with giving your money to be used
by a company and where you could potentially be at a risk of not getting payments. Understanding
the time value of money and calculating the present and future values can help investors determine
how much an investment is truly worth. Especially since investments, such as stocks and bonds,
offer gains at different timesc(Alali et al. 2021).
Furthermore, time value of money can help you achieve your investing goals. In the sense
that, if you know the interest percentage & the number of years you want to invest, to reach a
certain gain goal, you can calculate how much you’ll need to invest today. Additionally, the future
value and the present value take into account compound interest or capital returns, which is an
additional significant factor for investors to remember when searching for successful investments
(Al Ghanem et al. 2021).
In various cases, these calculations can help investors realize the true worth of the money
now compared to its future potential gains. For example, a business decision that results in a $
100,000 profit in the first year could be a better investment decision than a business decision,
which results in a $ 102,000 return after five years, even though we can see that the second option
has $ 2000 more gains than the first. This is because you could potentially gain more by going
with the first investment and taking the $ 100,000 gains and reinvesting it with a higher rate of
return. Moreover, the time value of money is an essential part of quantifying the influence inflation
has on our money. (Merritt, 2020)
The benefit of using the time value of money concept is that it can also help investors
compare investments to each other to determine which one will produce more gains and therefore
which one is a better decision. They can do so by using the formula to turn all the future cash flows
into the present value, then adding them up to get the total amount of each investment. This will
result in the net present value of each investment. If the NPV is a positive value, then that means
the investment is worth it; While a negative NPV means that it is not worth the investment. In the
case of evaluating and comparing two or more projects, the higher the NPV the more profitable an
investment is and the better the investment decision is.
Bibliography
Brightscape, Inc. (2019, August 1). What is the Time Value of Money (TVM) and How You Can
Use it to Help Plot Out Your Financial Future. Retrieved from Brightscape:
https://brightscape.com/insight/what-is-the-time-value-of-money-tvm-and-how-you-can-
use-it-to-help-plot-out-your-financial-
future#:~:text=The%20time%20value%20of%20money%20is%20important%20because
%20it%20allows,%2C%20inflation%2C%20risk%20and%20return.
Investopedia. (2020, November 19). Time Value of Money (TVM). Retrieved from
Investopedia: https://www.investopedia.com/terms/t/timevalueofmoney.asp
Merritt, C. (2020, November 19). How Does the Time Value of Money Affect Businesses?
Retrieved from azcentral: https://yourbusiness.azcentral.com/time-value-money-affect-
businesses-24538.html
Al Ghanem, K., and Al Qubaisi, N., Al Zaabi, H., Al Dhahmani, L., Al Naqbi, A., Al
Dhanhani, H., Al Shamisi, F., and Nobanee, H. (2021), Financial Analysis of
AstraZeneca .Available at SSRN: https://ssrn.com/abstract=3895292 or
http://dx.doi.org/10.2139/ssrn.3895292
Alali, E., Alhammadi, N., Almarar, M.S., Almheiri, S., Almarar, F., Almarar, M., Alremaithi,
L.S, and Nobanee, H. (2021) Financial Analysis and Performance Evaluation of
Moderna. Available at SSRN: https://ssrn.com/abstract=3896199 or
http://dx.doi.org/10.2139/ssrn.3896199
