Question

Why does money have a time value? Provide at least one real-life scenario in which you can apply the concept of time value of money?

Answer 1

The concept of Time value of money:
The value of money available today is worth more than the same sum in some time in the future. This happens due to the earning potential of money which means interest can be earned on idle money by investing.

The formula for time value of money is:
Future value=Present value*(1 + Interest rate)^(Time period)

Scenario:
Suppose we invest an amount of $1000 today at an interest rate of 5%.
Value of the $1000 one year from today is:
Future value=1000*(1 + 5%)^(1)
=1000*1.05
=$1050

Similarly the present value of $1000 received one year from today at 5% rate of interest is calculated as:
Present value=(Future value)/(1 + Interest rate)^(Time period)
Present value=(1000)/(1 + 5%)^(1)
=(1000)/1.05
=$952.38