A dollar received today is worth more than a dollar received yesterday. That is the essence of the time value of money. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received.

It is essential to understand the time value of money concepts and formulas presented below, but reliance on the formulas alone is not realistic to pass the CFP exam. Exam takers also must master the use of a financial calculator to have any realistic chance of passing the exam.


There are several different brands of financial calculators available on the market, but the financial calculator of choice for CFP exam takers is the HP 12C by Hewlett Packard.

Reference:
Understanding the Time Value of Money

Present value
The amount that a future lump sum is worth today given a specified rate of return.

An investment that earns 10% per year and can be redeemed for $1,000 in five years would have a present value of $620. In other words, $620 today is worth $1,000 in five years.

Formula
PV = FV / (1 + i)n
FV = future value
PV = present value
I = interest rate
N = compounding period

Future value
The value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.

Formula
FV = PV(1+i)n

FV = future value
PV = present value
I = interest rate
N = compounding period


Consider the following example:

$1000 invested for 5 years at 10%, compounded annually has a future value of $1,610.51.

FV = $1,000(1+.10)5
= $1,000(1.10)5
= $1,610.51


Ordinary annuity, Annuity Due and Net Present Value

Related Articles
  1. Investing

    Calculating the Present Value of an Annuity

    The present value of an annuity is the current, lump sum value of periodic future payments as calculated using a specific rate.
  2. Investing

    Market Value Versus Book Value

    Understanding the difference between book value and market value is a simple yet fundamentally critical component to analyze a company for investment.
  3. Investing

    Accelerating Returns With Continuous Compounding

    Investopedia explains the natural log and exponential functions used to calculate this value.
  4. Financial Advisor

    Hiring a Financial Advisor? Look for the CFP Label

    Don’t skimp on the CFP designation. Here's why those three letters show that someone is qualified in financial and investment planning.
  5. Small Business

    Calculating Net Present Value at Different Points Using Excel

    Calculating the net present value (NPV) of your investment projects using Excel.
  6. Financial Advisor

    Value Investing Strategies in a Volatile Market

    Volatile markets are a scary time for uneducated investors, but value investors use volatile periods as an opportunity to buy stocks at a discount.
  7. Personal Finance

    Prepare For Your CFA Exams

    Find out how to get yourself ready for these lengthy and often daunting exams.
  8. Personal Finance

    How Interest Rates Work on Savings Accounts

    Here's what you need to know to grow your rainy-day fund.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center