Definition
The Time Value of Money (TVM) is the financial principle that a dollar today is worth more than a dollar in the future. Money available now can be invested to earn returns, making it more valuable than the same amount received later.
Why It Exists
- Opportunity cost: Capital can be invested to earn returns.
- Inflation: Purchasing power declines over time.
- Risk: Future cash flows are uncertain.
Core Concepts
- Compounding: Growing money forward in time.
- Discounting: Converting future cash flows to present value.
- Present Value (PV)
- Future Value (FV)
- Discount Rate: Required return reflecting risk and opportunity cost.
Key Formulas
Future Value:
FV = PV × (1 + r)n
Present Value:
PV = FV ÷ (1 + r)n
Where:
- r = discount rate
- n = number of periods
Applications in Real Estate
- Discounted Cash Flow (DCF) analysis
- Net Present Value (NPV)
- Internal Rate of Return (IRR)
- Loan amortization schedules
- Development feasibility modeling
Example
You expect to receive $1,000,000 from a property sale in five years. If your required return is 10%, the present value is:
PV = 1,000,000 ÷ (1.10)5 ≈ $620,921
This means receiving $1,000,000 in five years is equivalent to about $620,921 today at a 10% required return.
Common Pitfalls
- Using unrealistic discount rates
- Ignoring timing differences
- Overreliance on IRR without cash flow analysis
- Confusing nominal and real returns