Time Value of Money
The concept of time value money gives that the money at hand today is more worth than the same amount in the future. Notably, this is due to inflation, which reduces the value of the money. Thus, if there is money that an individual is promised for a future period, it could be better to insist on getting the pay sooner rather than later. Normally, a discount factor is taken to help deduce the future value of money in the present, which translates to a present value of money given the future payment of cash flow (Muda & Hasibuan, 2018). My example will support understanding the time value of money concept.
Assume I have $ 10,000 today, which I could invest by depositing them at a bank at an interest rate of 10%. However, the money I have is the pay I’m expecting from a friend and colleague (a healthcare provider) who owes me money. The colleague has offered to pay back the debt the following year, having added $500. If the friend gives me the money today and I invest it in the bank, I would have $11,000 after one year. Therefore, I am supposed to consider which option is better. From the look of things, the option to take the money owed to me at present and invest it in a bank is better because the value of the money will have changed by $1,000 within one year. In other words, if I accept to be paid by my friend after one year, I will likely make a loss in the value of my money by $500. Thus, the time value of money concept allows one to avoid losses in the value of money held today as time goes by due to inflation, which subjects the money to losing value.
Muda, I., & Hasibuan, A. N. (2018). Public discovery of the concept of the time value of money with the economic value of time. In Proceedings of MICoMS 2017. Emerald Publishing Limited. https://doi.org/10.1108/978-1-78756-793-1-00050
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Describe your personal example(s) of the time value of money or opportunity cost. Try to explain either concept to non-finance majors. What examples can you think of in your career field?
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