Time Value of Money

What will be your choice?

What will be your decision?

Definition of Time Value of Money.

To start our discussion, we shall first visit the concept of Time Value of Money.

Time Value of Money is a concept rather important for us to understand inflation and investment. It is one of the useful tool to make investment decision and also to correctly calculate the real return of an investment.

One of the important parameter in TVM calculation will be the potential earning capacity. Interest rate for fixed deposit account is one of the typical example of potential earning capacity and it is deemed risk free.

Scenario with 3% interest rate.

For option 1, there will be no calculation involved. For option 2, for each RM 100,000 to be received in the future will be equivalent to a value today (PV). When we sum up all of these, we will get an equivalent value today.

From the above calculation, we can know that the present value for option 2 will be equivalent to RM 557,970. This is higher than option 1, therefore we can conclude that based on 3% p.a. interest rate, Option 2 is the better option.

Scenario with 8% interest rate.

The decision will be different when the interest rate is 8%. From above table, the total present value will be RM 499,271 for option 2. This is lower that RM 500,000. Therefore, Option 1 is now the better option.

Reference for PV & FV Formula.