Why is money today worth more than money tomorrow?

In this video, we will explore a fundamental concept in corporate finance: the time value of money.

This principle is crucial for making investment decisions and involves calculating the present and future values of cash flows. We’ll begin by defining the time value of money, which essentially states that money today is more valuable than money in the future. There are three primary reasons for this: the preference for present consumption over future consumption, the impact of monetary inflation eroding the value of future money, and the role of uncertainty or risk. These factors are encapsulated in the discount rate, which represents the rate at which present and future cash flows are exchanged.

The discount rate is also an opportunity cost, reflecting the potential return an individual foregoes by not investing money today in projects with similar risk and return profiles. We will learn how to calculate present and future values, crucial for comparing cash flows occurring at different points in time. Using examples, we will see how cash flows can be converted to their present and future values by applying the time value of money principle. Additionally, we’ll explore the concept of Net Present Value (NPV), which helps determine whether an investment project is economically viable by considering both the initial investment and the future cash flows, all properly discounted to the present value.