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Time Value of Money or TVM states that the present value of a particular amount of money is always more than its future value. According to the time value of money concept, an investor likes to receive a particular amount of money today instead of receiving the same amount in the future.
The time value of money is that type of investment theory, which mentions that the value of money is more today compared to its value in the future because of inflation and other economic factors.
The essence lies in the idea that the money, which an individual has with him is greater than the same amount of money which will be received in the future due to the reason that money is ready to be invested and it will bring in interest over time. So the money has greater value the sooner it is received.
If cash is received today instead of the future, the money can yield significant return if invested to any alternative option. The future value refers to the amount of money acquired with the help of growth in investments in the long run bearing a particular interest rate. It represents the value of money at a specific time in the future. On the other hand present value indicates to the value of a particular amount at the present time.
The different types of calculation methods that are used for calculation of time value of money include the following:
Present Value (PV) of an amount which is going to be received in the future
Future Value (FV) of an amount which has been invested (for example bank deposits) at the present time at a specific interest rate
Present Value of an Annuity (PVA) refers to the present value of a flow of equated future payments, for example, a mortgage
Future Value of an Annuity (FVA) refers to the future value of a flow of payments (annuities), presuming that the payments are endowed at a particular rate of interest
Present Value of a Perpetuity refers to that value of a continuous flow of payments which is perpetual or indefinite
Every calculation regarding the time value of money is based on the most fundamental formula, which is called as the present value of future amount of money.
The theory of time value of money is frequently applied in areas of mortgage loans and retirement plans.