Future Value of Money

The analysis of money and time is paramount in financial decision making. Time value of money concepts such as present value of money vs. future value of money are used to calculate and to compare the values of sums of money at different points in time.

 

The “time value of money” refers to the fact that a dollar today is worth more than a dollar in the future (due to inflation). We all know this intuitively.  What you can buy for one dollar today will cost you much more than a dollar in the distant future. Similarly, what you can buy for a dollar today would have cost much less than a dollar in the past.

 

Consider the following example:  Assume somebody owes you $100.  You would rather get the $100 now than in 5 years’ time.  This is intuitive to us all.  On one hand, the $100 bill is worth $100 both now and in 5 years’ time.  But because of inflation the $100 bill will buy you less in 5 years than you could buy now.  Similarly, if you invest the $100 bill now, it will be worth more than $100 in 5 years’ time.

 

The future value of a dollar is simply what the dollar, or any amount of money, will be worth if it earns interest for a specific time.  So, if you got the $100 now rather than in 5 years, the future value of that $100 in 5 years will be more than $100.

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