## The Time Value Of Money

Everyone knows that a dollar today is worth more than a dollar a year from now. The reason for this is because of the time value of money. To illustrate the time value of money, let us look at the following equation:

FV = PV(1 + k)n where FV = Future value of an investment

PV = Present value k = Investment interest rate (or cost of capital)

n = Number of years

Using this formula, we can see that an investment of \$1,000 today (i.e., PV) invested at 10% (i.e., k) for one year (i.e., n) will give us a future value of \$1,100. If the investment is for two years, then the future value would be worth \$1,210.

Now, let us look at the formula from a different perspective. If an investment yields \$1,000 a year from now, then how much is it worth today if the cost of money is 10%? To solve the problem, we must discount future values to the present for comparison purposes. This is referred to as "discounted cash flows."

The previous equation can be written as:

Using the data given: