Time Value of Money

Summary

This video explains the concept of the time value of money, highlighting how money received today is worth more than money received in the future due to interest rates and compounding. It covers key concepts like future and present value, compounding, and discounting. The video also introduces essential formulas and tools, such as Excel functions (FV, PV, Rate, and Per), to help calculate these values. Additionally, it explains how to determine the return on investment and the number of periods required for an investment to grow, using both manual calculations and Excel.

Takeaways

• 😀 The time value of money (TVM) means that money received today is worth more than the same amount received in the future.
• 😀 Future value (FV) is determined by the number of periods and the interest rate applied, which increases the amount over time.
• 😀 Present value (PV) is the current value of money that will be received in the future, discounted by the interest rate and time periods.
• 😀 The time value of money impacts many financial decisions, including loans, mortgages, investments, and business ventures.
• 😀 Investors prefer having money now rather than later, as money today can earn interest and grow in value.
• 😀 Compounding occurs when interest is earned not only on the initial principal but also on the accumulated interest from previous periods.
• 😀 To calculate the future value (FV), the formula used is FV = PV × (1 + r)^t, where r is the interest rate, and t is the time period.
• 😀 The future value of a sum can be easily calculated in Excel using the FV function by inputting rate, period, and present value.
• 😀 The present value formula is PV = FV × (1 / (1 + r)^t), which discounts the future value to determine its worth today.
• 😀 Excel's PV function helps calculate present value easily by referencing the rate, periods, and future value.
• 😀 The interest rate, periods, or time can be calculated using the formula r = (FV / PV)^(1/t) - 1 or using Excel's RATE function.

Q & A

What is the concept of Time Value of Money (TVM)?

The Time Value of Money (TVM) refers to the idea that money today is worth more than the same amount of money in the future. This concept is based on the potential earning capacity of money, as money can be invested to earn interest over time.

Why is a peso received today worth more than a peso received in the future?

A peso received today is worth more than a peso received in the future due to the opportunity to earn interest or returns on that money over time. Money in hand today can be invested to generate additional wealth.

What is the difference between future value (FV) and present value (PV)?

Future value (FV) is the value of a sum of money after it has been invested or compounded over time at a specific interest rate. Present value (PV) is the value today of a sum of money to be received or paid in the future, discounted by the interest rate over a set period.

How do investors use the concept of TVM in business and investment decisions?

Investors use TVM to evaluate business loans, mortgage payments, or the true return on an investment. It helps them understand the financial impact of receiving or paying money today versus in the future, thus aiding in better decision-making regarding capital allocation and investments.

What is the formula for calculating future value (FV)?

The formula for future value (FV) is: FV = PV × (1 + r)^t, where PV is the present value, r is the interest rate per period, and t is the number of periods.

How does compounding work in calculating the future value of an investment?

Compounding refers to the process where the interest earned on an investment is added to the principal, so that future interest is calculated on the increased amount. Over time, this leads to exponential growth in the value of the investment.

How can Excel functions be used to calculate the future value (FV)?

In Excel, the FV function can be used to calculate the future value. The syntax is: =FV(rate, nper, pmt, pv, type), where 'rate' is the interest rate, 'nper' is the number of periods, 'pmt' is the payment per period (which is zero for a single lump sum), and 'pv' is the present value.

What is the formula for calculating present value (PV) from future value (FV)?

The formula for calculating present value (PV) is: PV = FV / (1 + r)^t, where FV is the future value, r is the interest rate per period, and t is the number of periods.

How can an investor calculate the interest rate (r) using TVM formulas?

The interest rate (r) can be calculated using the formula: r = (FV / PV)^(1/t) - 1, where FV is the future value, PV is the present value, and t is the number of periods.

What is the formula to calculate the number of periods (t) needed for an investment to grow to a specific future value?

The formula to calculate the number of periods (t) is: t = log(FV / PV) / log(1 + r), where FV is the future value, PV is the present value, and r is the interest rate per period.