The concept of the time value of money refers to the financial principle noting that a fixed amount of money currently is worth more than the same amount of money in the future. This is explained through the presence of inflation and the earning capacity of money. Provided an interest rate can be earned on a certain monetary sum, this sum’s worth is greater the sooner it is received. The present money can begin to earn its interest as soon as it is received while receiving the same amount in the future does not allow the holder to capitalize on the money’s earning capacity (Rossolillo N., 2021). Consecutively, money received in the future indicates financial losses if compared with the same amount of money received at present.
This principle lies behind the most frequent ways of designing and outlining investment and dividend options. Shareholders are faced with the choice of receiving smaller amounts of money immediately as opposed to larger ones in the future. The greater sum of a delayed return compensates for the loss of the dividend’s earning potential. By understanding the time value of money, one can understand the investment decisions, as well as the attractiveness of certain deals. The greater the interest rate provided on money, the greater is the incentive for the investors to attempt to secure it as soon as possible. The time value of money is an instrumental concept in economics as it provides a contextual framework for investments analysis. The formula attached to it allows the researcher to calculate the incentive of receiving the money in the short term by taking into account the size of the sum and the interest rate.
Reference
Rossolillo N. (2021). What Is the Time Value of Money (TVM)?The Motley Fool.