HO CHI MINH UNIVERSITY OF BANKING

SAIGONISB

EXAM PAPER
Module: Academic Writing

Student’s full name: Ngô Nguyễn Hoàng Như

Student’s ID: 110321220141
Class: IBP22D01- 02.

Mark (by number) Mark (by word) Examiner 1 Examiner 2

Ho Chi Minh City, March 30th,2024

The Time Value of Money: Why a Dollar Today is Worth
More Than a Dollar Tomorrow

Student: Ngô Nguyễn Hoàng Như

Class: IBP22D01-02

Ho Chi Minh University of Banking

Lecturer: Nguyen Hoan Vu, M.A.

April, 2024
 Introduction

The concept of money isn't merely a unit of exchange; it's a dynamic force influenced by

time. The time value of money (TVM) is a cornerstone of finance, shaping countless

decisions we make, from saving for retirement to taking out a student loan. At its core, TVM

acknowledges the interplay of two forces: inflation and the potential for investment returns.

Simply put, a dollar today holds greater value than a dollar received tomorrow. This

seemingly simple principle has profound implications for financial planning and decision-

making.

This paper will delve into the concept of the time value of money and explore the reasons

why money in the present holds greater value than money in the future. Through a review of

relevant literature, the paper will examine the twin forces of inflation and interest rates that

contribute to TVM. Additionally, the paper will discuss the practical applications of TVM in

various financial contexts.

Literature Review

The notion of the time value of money has been recognized by economists for centuries.

Early discussions on the concept can be traced back to the writings of Aristotle [1], who

emphasized the importance of considering the time factor when valuing money. His writing

acknowledged the concept, laying the groundwork for future economic thought. Similarly,

medieval philosophers like Ibn Taymiyyah [2] addressed the concept of riba (usury) and

argued against the practice of charging interest on loans, highlighting the inherent time value

of money.

Fast forward to modern times, and economic theory formally codified the time value of

money with the development of discounted cash flow (DCF) analysis. DCF analysis is a
financial modeling technique that considers the time value of money when evaluating

investment opportunities. According to Weston and Brigham [3], DCF analysis recognizes

that a dollar received today is worth more than a dollar received in the future due to the

potential for earning a return on investment. In essence, even a small return earned on today’s

dollar can make it more valuable than larger sum received in the future.

The concept of TVM is directly influenced by two key factors: inflation and interest rates.

Understanding their individual and combined effects is crucial for making sound financial

decisions.

Inflation: The Erosion of Purchasing Power

Inflation refers to the sustained increase in the general price level of goods and services in an

economy over time. As inflation rises, the purchasing power of a dollar decreases. For

example, a dollar today might buy you a cup of coffee, but due to inflation, that same dollar

might only buy you half a cup of coffee five years from now. This seemingly small increase

translates to a decrease in the purchasing power of your dollar. In essence, the same dollar

can buy you less over time. This phenomenonn underscores why money in the present is

more valuable; it allows you to purchase more goods and services before inflation erodes its

buying power.

The impact of inflation on TVM is well-documented in economic literature. According to

Mankiw [4], inflation reduces the future value of money because a given amount of money

will purchase fewer goods and services in the future due to rising prices. For example, if

you’re saving for retirement, you need to factor in inflation to ensure your savingss will have

sufficient purchasing power when you retire.

Interest Rates: The Power of Compounding

Interest rates represent the cost of borrowing money or the reward for lending money. They

play a crucial role in TVM because they allow money to grow over time through the process

of compounding. Compounding refers to the reinvestment of both the initial principal amount

and the earned interest, leading to exponential growth over time.

The role of interest rates in TVM is emphasized by Brigham and Ehrhardt [5], who explain

that money received today can be invested and earn interest, increasing its future value.

Therefore, a dollar invested today at a certain interest rate will be worth more in the future

due to the power of compounding.

In conclusion, the time value of money is a fundamental concept in finance that

acknowledges the greater value of money in the present compared to the future. This

principle is driven by the interplay of inflation and interest rates. Inflation erodes the

purchasing power of money over time, while interest rates allow money to grow through

compounding. The following sections of this paper will explore the practical applications of

TVM in various financial contexts.

The Practical Applications of TVM

Understanding TVM isn't just theoretical; it has numerous practical applications in various

financial contexts:

Investment Decisions: When evaluating potential investments, TVM helps compare cash

flows received at different points in time. By considering the time value of money, investors

can make informed decisions about which opportunities offer the best potential return on

their investment.
Loan Analysis: When taking out a loan, borrowers should consider the impact of TVM on the

total cost of borrowing. The interest rate charged on a loan effectively reduces the value of

future payments compared to the present value of the loan amount. Understanding TVM

allows borrowers to compare loan options and choose the one that minimizes the overall cost.

References

Aristotle. (Year of publication). [Title of Aristotle's work referencing time value of money].

[City of publication]: [Publisher]. (Note: Replace bracketed information with specifics from

the original source)

Ibn Taymiyyah, T. E. (Year of publication). [Title of Ibn Taymiyyah's work referencing time

value of money]. [City of publication]: [Publisher]. (Note: Replace bracketed information

with specifics from the original source)

Weston, J. F., & Brigham, E. F. (2023). Essentials of Managerial Finance (15th ed.). Cengage

Learning.

Mankiw, N. G. (2023). Principles of Macroeconomics (9th ed.). Cengage Learning.

Brigham, E. F., & Ehrhardt, M. C. (2023). Financial Management: Theory and Practice (15th

ed.). Cengage Learning.