What is the time value of money. How can time value of money be used in making financial decisions?

The time value of money is one of the corner stones of finance. It states that a dollar now is worth more compared to dollar later in time. And if you think about it, it is correct. Here is why:

Imagine two situations:

- you have a $1000 now in your pocket

- you will receive $1000 in one year

Lets say that you do NOT need the $1000 now or later; however you would like to have them.

Now, if you had the money in your pocket today and you don't need them, what you can do is to invest them in the back and maybe you can earn couple of % interest on them (this will at least help you negate the effects of inflation).

However, if you are to receive the money in one year, you will have to pass on the opportunity to invest and make some interest on them. Moreover, when you receive the money next year, they will be a $1000; however their buying power will be slightly less thanks to inflation.

So to summarize - money now are worth more because they are at your disposal and they can earn you interest. Money later earn you no interest and suffer from inflation (alright, they gain from deflation too; however money in the bank do that too).

This is a simple example but you can imagine in different terms

• lets say a company receiving money to pay off debt today rather

in a month, thus saving some interest costs.