Cost of Time (Time is Money)
Introduction
The time value of money (in English, time value of money, usually abbreviated as TVM) is an economic concept based on the premise that an investor prefers to receive a payment of a fixed sum of money today, rather than receiving the same face value at a certain future date. This preference is because, if the investor receives the money today, he could reinvest the money to obtain a larger amount on that date, due to the interest generated by said investment.
Many authors mistakenly relate the "time value of money" to inflation. Since, as explained above, the investor could find himself in a context without inflation and make an investment to obtain interest. And although expected inflation influences the value of the interest generated by the investment (being higher the greater the expected inflation), investments are made with a certain interest rate even with zero expected inflation.
Calculations
All formulas related to this concept are based on the same basic formula, the present value of a future sum of money, discounted to the present. For example, a sum FV to be received one year from now must be discounted (at an appropriate rate r) to obtain the present value, PV.
Some of the common calculations based on the time value of money are:.
There is a basic set of equations that represent the operations listed above. Solutions can be calculated (in most cases) using formulas, a financial calculator or a spreadsheet. Formulas are programmed into almost all financial calculators, and some spreadsheet programs also have them available to the user (for example, PV, FV, RATE, NPER, and PMT).[1].
For any of the equations, the formulas can be used to determine any of the unknown variables. In the case of interest rates, however, there is no mathematical procedure to solve them, so the only way to do it is through trial and error (for these cases, a financial calculator or spreadsheet is extremely useful, since the tests take fractions of a second).
The equations are frequently combined for particular uses. For example, the bond price "Bond (finance)") can be calculated using these equations.
For annuity calculations, it must be clear whether payments are made at the beginning or at the end of the period.