Time Value of Money - Present Value vs Future Value

Summary

This video explains the concepts of future value and present value, illustrating the time value of money. It demonstrates how $10,000 today will grow to $32,071.35 in 20 years at a 6% annual interest rate, and conversely, how $100,000 ten years in the future has a present value of $55,839.48. The script emphasizes the diminishing purchasing power of money over time, highlighting why the same amount of money today has more value than in the future.

Takeaways

• 💡 The present value (PV) is the value of money today, while the future value (FV) is the value of that money in the future.
• 🔢 The formula to calculate FV is FV = PV * (1 + r)^n, where r is the annual interest rate and n is the number of years.
• 🌐 If you invest $10,000 today at a 6% annual interest rate, it will be worth $32,071.35 in 20 years.
• 💸 The time value of money concept shows that money today has a higher purchasing power than the same amount in the future.
• 🛒 An example of purchasing power is that $1 today can buy more goods than it could 20 years ago.
• 📉 The formula to calculate the present value is PV = FV / (1 + r)^n, which is used to find the current value of a future sum.
• 💲 The present value of $100,000 ten years from now, at a 6% interest rate, is $55,839.48.
• 📈 Inflation affects the time value of money; a 6% inflation rate means that $55,839.48 today has the same purchasing power as $100,000 in the future.
• 🏦 The script illustrates that the same amount of money is worth more in the present than it will be in the future due to the time value of money.
• 🤔 If given a choice between receiving $1,000 now or in ten years, the $1,000 now has more purchasing power.
• 📚 Understanding the time value of money is crucial for making informed financial decisions and understanding the impact of interest and inflation on savings and investments.

Q & A

What is the concept of present value in finance?

The present value of money represents the value of money today, as opposed to its value in the future. It's the amount of money that, if invested now at a given interest rate, would grow to a specified future value.

What is the formula used to calculate the future value of an investment?

The formula to calculate the future value (FV) is FV = PV * (1 + r)^n, where PV is the present value, r is the annual interest rate, and n is the number of years the money is invested or will be invested for.

What is the future value of $10,000 after 20 years with an annual interest rate of 6%?

Using the future value formula, the future value of $10,000 after 20 years with an annual interest rate of 6% is $32,071.35.

What does the time value of money illustrate?

The time value of money illustrates that a dollar today is worth more than a dollar in the future due to its potential earning capacity, which is affected by factors like inflation and interest rates.

How does the purchasing power of money change over time?

The purchasing power of money decreases over time due to inflation and other economic factors, meaning that the same amount of money can buy less in the future than it can today.

What is the concept of future value in finance?

The future value of money represents the value of an amount of money at a future date, considering a specific interest rate. It's the amount that money will grow to if it is invested now.

What is the formula used to calculate the present value of a future sum of money?

The formula to calculate the present value (PV) is PV = FV / (1 + r)^n, where FV is the future value, r is the annual interest rate, and n is the number of years until the future value is received.

What is the present value of $100,000 ten years from now with an annual interest rate of 6%?

Using the present value formula, the present value of $100,000 ten years from now with an annual interest rate of 6% is $55,839.48.

Why is the present value of a future sum of money less than the future sum itself?

The present value is less than the future sum because it takes into account the time value of money, meaning that money available now can be invested to earn interest, and thus is worth more than the same amount in the future.

How does inflation affect the value of money?

Inflation erodes the purchasing power of money over time, meaning that the same amount of money will buy fewer goods and services in the future as it does today.

What is the implication of the time value of money for financial decision-making?

The time value of money implies that when making financial decisions, one should consider the present value of future cash flows and the potential earnings or savings that can be made by investing money now rather than in the future.