Time Value of Money Definition and How to Calculate it

Definition of Time Value of Money and How to Calculate it – Time Value of Money is one of the basic theories in money management. This theory or concept of Time Value of Money states that the value of money we have today is higher than the value of money with the same amount in the future.

For example, the price of granulated sugar per kilogram in 2011 was around $. 1, -, but in 2017 the price has increased to $ 14 per kilogram, which is up about 40% from the previous 6 years. In the next 6 years, the price of sugar is also likely to rise higher than the current price. This shows that the value of money can change over time.

With the same concept, if we save $10,000, – on bank deposits with a certain interest at this time, then 6 years later the amount of our money will also increase due to additional interest from the bank. Therefore, the Concept or Theory of Time Value of Money can generally be used as one of the basic considerations in making decisions to invest, save, give loans, and determine rental rates.

Formula and How to Calculate Time Value of Money

In the concept of Time Value of Money, there are several terms that we need to know, namely Present ValueFuture Value, and Interest. The formula for Calculating Time Value of Money is as follows:

Formulas to Calculate Future Value (Value Coming)

Fn = P (1 + i) n

Formulas to Calculate Present Value (present value)

P = Fn / (1 + i) n

Information :

  • Fn = Future Value in the nth year
  • P = Present Value
  • i = Interest
  • n = Number of Years

Example Calculation of Time Value of Money (Time Value of Money)

Example 1:

We have $ 10,000,000 and we will deposit it into the bank with 5% interest per year. What is the value of the money in the next 5 years?

Solution

Known :

  • P = $ 10,000,000 –
  • i = 5% or 0.05
  • n = 5 years
  • Fn =?

Answer:

Fn = P (1 + i) n

  • Fn = 10,000,000 (1 + 0.05) 5
  • Fn = 10,000 (1,05) 5
  • Fn = 12.762.816

So in the next 5 years, the amount of money we will receive is $ 12,762,816.63.

Example 2:

If we want the money of $ 20,000,000, – in the next 10 years, how much should we save to the Bank Deposit that the interest rate is 5%?

Known :

  • Fn = 20,000,000
  • i = 5% or 0.05
  • n = 10
  • P =?

Answer:

P = Fn / (1 + i) n

  • P = 20.000.000 / (1 + 0,05)10
  • P = 20.000.000 / (1,05) 10
  • P = 15.670.523,33

So now, we have to save as much as $ 15,670,523.33 to get $ 20,000,000 in the next 10 years.

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