3. What is time value of money?
Time value of money is the concept that the value of a dollar to be received in future is less than the value of a dollar on hand today.
There are 5 major components of time value – rates, time periods, present value, future value, and payments.
Rational investors prefer to receive money today rather than the same amount of money in the future because of money's potential to grow in value over a given period of time.
Time value is also related to the concepts of inflation. Inflation constantly erodes the value, and therefore the purchasing power of money. If the rate of inflation is higher than the rate of your investment return, then, although your investment shows a positive return, you may be losing money in terms of purchasing power.
Companies consider the time value of money in making decisions about investing in new product development, acquiring new equipment or facilities, or setting up credit terms for the sale of their products or services.
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