The **time value of money principle** must first be grasped in order to have a solid foundation in finance. Time value of money can be calculated as:

**Present value** – Current worth of a future sum of cash given a specified rate of return.

Present Value = Future value x [1 / (1 + interest)]^time

**Future value** – Future value is the value of an asset or cash at a specified date in the future.

Future Value = Present value x (1 + interest)^time

**Example:**

Assuming that a bank pays an interest of 10%, if I deposit P100 now, how much will it be next year? Answer is: **P110** [P 100 x (1 + .10)].

P110 is the **future value** of your 100 pesos deposited now in the bank that pays 10% interest.

Assuming that current interest to borrow cash is 10%, if Jose approached you and offered you P110 after 1 year, how much will you give him **today** for a future value of P110?

Answer is: **P100** [P110 x (1/1.10)]

P100 is the **present value** of 110 pesos to be received in the future.

**To further illustrate:**

The Present value simply **discounts** the future interest income to be earned hence the term ‘discounted’ in Discounted Cash Flow (DCF) Method of valuation.

There are only three approaches to valuation: **Relative valuation**, **Contingent claim valuation** and **DCF valuation**.

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