Back to: Financial Management
Good day, class! I hope you’re enjoying the course so far and beginning to see how useful these financial concepts are in real life.
Today’s topic is one of the most important ideas in finance, and although it might sound a little technical at first, don’t worry—I’ll break it down so it’s easy to understand. Our focus this week is on the Time Value of Money.
Let’s start with a simple question: If someone gave you ₦1,000 today or offered to give you ₦1,000 in one year, which would you choose?
Most people would choose to take the ₦1,000 today. But why? That’s the time value of money in action.
Time Value of Money II
The time value of money (TVM) means that money available now is worth more than the same amount in the future. Why? Because money today can be used to earn more money. You could save it in a bank and earn interest.
You could invest it in a business or even buy something that appreciates in value. The longer you wait, the more you lose that opportunity.
There are two key parts to this idea:
Present Value (PV) – This is the value today of a certain amount of money you expect to receive in the future.
Future Value (FV) – This is the amount your money will grow to after a certain period, if you invest it or earn interest.
Let’s take a simple example. If you put ₦1,000 in a savings account that pays 10% interest per year, in one year, you will have: ₦1,000 + (10% of ₦1,000) = ₦1,100
That extra ₦100 is your interest—the reward for not spending the money now and letting it grow. This process is called compounding.
The longer you leave your money, the more it grows. In Year 2, you’ll earn interest not just on the original ₦1,000, but also on the ₦100 interest from Year 1. That’s compound interest. After Year 2: ₦1,100 + (10% of ₦1,100) = ₦1,210
On the flip side, when someone promises to pay you ₦1,100 a year from now, we need to calculate how much that is worth today. That’s where present value comes in.
The formula for Present Value is: PV = FV / (1 + r)^n
Where:
– FV is the future value (₦1,100 in our case)
– r is the interest rate (e.g. 0.10 for 10%)
– n is the number of years
Using the formula:
PV = ₦1,100 / (1 + 0.10)^1 = ₦1,000
So, if someone offers you ₦1,100 in one year, it’s worth ₦1,000 today if the interest rate is 10%. That’s why we often prefer money now rather than later—because money today gives us options.
Understanding TVM helps businesses and individuals make smart choices. For example: – Should a business accept ₦500,000 today or ₦600,000 in two years? – Should you borrow money today or wait? – Is it worth investing in a project that pays back slowly?
The answer to these questions depends on the time value of money. Every financial manager must consider this when making decisions about loans, investments, and savings.
To summarise, the time value of money reminds us that money has a time cost. It’s better to receive money sooner and invest it than to wait and risk losing value over time. This concept forms the backbone of many financial calculations you will see later in this course.
For practice, think of a real-life situation where you’ve had to choose between receiving something now or later. Try to apply the idea of interest or opportunity cost and see which was better.