Handout-1 Time Value of Money Spring-2023

Time Value of Money: central concept in finance theory

The basic principle of finance: A dollar today is worth more than a dollar tomorrow, because the
dollar today can be invested to start earning interest immediately.
Principles of Corporate Finance (Brealey, Myers)
The idea that money available at the present time is worth more than the same amount in the
future due to its potential earning capacity. This core principle of finance holds that, provided
money can earn interest, any amount of money is worth more the sooner it is received.
Everyone knows that money deposited in a savings account will earn interest. Because of this
universal fact, we would prefer to receive money today rather than the same amount in the
future.
For example, assuming a 5% interest rate, $100 invested today will be worth $105 in one year
($100 multiplied by 1.05). Conversely, $100 received one year from now is only worth $95.24
today ($100 divided by 1.05), assuming a 5% interest rate.

Future Value The value to which a particular investment will grow after ‘t’ years with
compound interest at an annual interest rate of ‘r’ percent.

Present Value The value today of a specified amount to be received in future (t years).

Net Present Value = PV – required (initial) investment

▪ FV = Future Value
▪ PV = Present Value
▪ i = the interest rate per period
▪ n= the number of compounding periods

Business Finance UCP-Business School