The time value of money
1. The dollar and time
Look at the following data:
|New honours graduate salary||$800 per year||$50,000 per year|
|3 bedroom house||$2,825||$400,000|
All monies are in dollars, but they clearly do not have the same value. The $ in 1963 was worth more than the one today. So a $ today is worth more than a $ tomorrow; a demonstration of the time value of money.
This approach is general, not specific or numerate. That is where discount tables come in.
2. Discount tables
Imagine that you invest $100 at 10% per annum, compounded annually. Your deposit would grow.
This is the future value of a $ today at 10%. We can turn this round and look at the present value of a $ earned in the future. It is the reciprocal of the numbers above.
Present value of $1 earned in the future.
This tells us that a $ received in 3 years time is worth the same as 75 cents today at 10% rate of interest.
Do the same thing for an interest rate of 20% and we get:
The higher the interest rate, the less money is worth received in the future.
For interest rate, read discount rate and you have the discount tables.