Time Value of Money

• Author: Vern Krishna
• Pages: 102-127

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Chapter 5: Time Value of Money

“Time is money.”

A. OVERVIEW

Money has no monetary value except when it is put in the context of

time. Stated alternatively: A dollar today is worth more than a dollar

tomorrow. e value of money depends upon the eect of time on

interest on investments. is basic principle of nance is the key to

investment, retirement, and tax planning.

Interest is the rental cost of borrowing money. For the borrower,

interest is the rent that they pay for borrowing money. For the lender,

interest is the income earned from lending money. ey are just dif-

ferent sides of the same coin. Hence, the time value of money per-

vades nance, accounting, law, and taxation.

B. IMPLICATIONS

ere are two dimensions of value: future and present. Given a sum

of money, we can determine its value at some future date if we know

the interest rate at which we can invest the money. Conversely, if we

know that we are to receive a sum of money in the future, we can

determine its value today if we know the rate at which it is, or can be,

invested. us, all money has “time value.”

Chapter 5: Time Value of Money 

ere are three factors to consider in determining the present or

future value of a sum of money: () the prevailing interest rate; ()

time; and () the net tax eect of earning or paying interest. In law-

suits, it is counsel’s responsibility to raise time value issues to deter-

mine the discounted value of judgments looking to lost prots or

anticipated future earnings. Judges do not make such calculations on

their own initiative. Counsel must educate them.

C. UNDERLYING FACTORS

e value of money depends upon three factors:

. Principal amount (P);

. Interest rate (r); and

. Time (n).

“Principal” is the amount of money originally borrowed or loaned.

“Interest” is compensation for use of money (similar to rent). Time

refers to the period of borrowing, lending, or investing.

All assets, tangible and intangible, can be expressed in terms of

their future or present value if we can determine the rate at which the

principal amount of the asset is invested or discounted over a period

of time.

e appropriate rate is usually the market-determined interest or

investment rate. In economic terms, “interest” is the rental cost of

borrowing money. As with all rentals, the cost of renting money may

be xed in advance, determinable at a future time, or variable accord-

ing to specied conditions. us, interest and time are inextricably

related. An interest rate is relevant if, and only if, it is related to time.

Although most of us learned about simple and compound interest

in school, we are less intuitive about the concept of the discounted

value of future sums of money. is is because we are taught to think

intuitively of investing for the future, but not of the present value

of sums of money to be received in the future. Yet, mathematically

 Lehrman v Gulf Oil Corp,  F.d ,  (th Cir , cert denied,  US

 ()).