Back to: Financial Management
Hello, everyone!
I hope you are well-prepared for today’s topic—it’s a crucial one and serves as the backbone of financial decision-making: the Time Value of Money (TVM).
This concept helps financial managers determine the value of money across time periods and make rational investment decisions.
Lesson Objectives:
By the end of this lesson, students should be able to:
Define the time value of money.
Explain the concepts of present value (PV) and future value (FV).
Apply basic formulas for PV and FV.
Understand the importance of TVM in investment and financing decisions.
Time Value of Money
TVM is the idea that a sum of money today is worth more than the same sum in the future due to its earning potential. It is based on the principle that money can earn interest, hence a delay in receiving money reduces its present worth.
Why is TVM Important?
Helps in evaluating investment options.
Assists in loan and mortgage calculations.
Useful in pension, insurance, and capital budgeting decisions.
Key Concepts:
1. Future Value (FV):
The amount a sum of money today will grow to in the future, based on a specific rate of return.
Formula:
FV = PV × (1 + r)ⁿ
Where:
PV = Present Value
r = interest rate
n = number of periods
Example:
If you invest ₦10,000 at 10% for 2 years:
FV = 10,000 × (1 + 0.10)² = ₦12,100
2. Present Value (PV):
The value today of a future amount of money.
Formula:
PV = FV ÷ (1 + r)ⁿ
Example:
What is the present value of ₦15,000 to be received in 3 years at 8%?
PV = 15,000 ÷ (1 + 0.08)³ = ₦11,907.48
3. Compounding vs Discounting:
Compounding is finding FV from PV.
Discounting is finding PV from FV.
Both are essential tools for making investment decisions.
Summary:
The time value of money tells us that money today is more valuable than money in the future. With the help of simple formulas, we can assess how money grows or loses value over time. This knowledge empowers financial managers to make smarter investment choices.
Class Activity / Discussion:
Practice Problems:
Calculate:
The future value of ₦5,000 invested for 5 years at 12%.
The present value of ₦20,000 to be received in 4 years at 10%.
Evaluation (Assessment Questions):
Explain in your own words what the time value of money means.
Calculate the future value of ₦7,000 invested at 9% for 3 years.
Find the present value of ₦25,000 to be received in 2 years at 6%.
Why is a naira today more valuable than a naira tomorrow?
What is the difference between compounding and discounting?