Chapter 3: Time Value of Money
In 1961, a box of Cheerios cost roughly 25¢. Today, a regular-sized box of Cheerios can cost as much as $5.00 at a grocery store or supermarket. What is the reason for the price increase, when the actual cereal hasn’t changed much in over 50 years? Here are some other questions to think about regarding this scenario:
- How much is a regular (non-collectable) 1961 quarter worth today?
- If you kept that quarter in your sock drawer until today, how much money would you have now?
- If you put the quarter in the bank in 1961, how much would be in the account today (assuming no bank fees or other transactions)?
- Alternatively, if you had purchased 25¢ of stock in Bell Canada Inc. in 1961, how much would your investment be worth today?
- Could you buy a box of Cheerios for 25 cents today? Why?
The answers to these questions lie in the concept of the time value of money (TVM): a dollar today is worth more than a dollar in the future.
The time value of money is a fundamental concept in engineering economics. It forms the basis for project decision making and is taken into account every time financial decisions are made. The two concepts associated with the time value of are:
These concepts will be discussed in detail in this chapter.
Key Concepts and Terms
- Inflation and deflation
- Simple vs. compounding interest
- Effect of time on the economic value of money
- Principles of economic equivalence
- Common types of cash flow series
After completing this chapter, students should be able to:
- Explain the concept of the time value of money
- Discuss inflation and interest as well as their applicability to financial decisions
- Explain the difference between simple and compounding interest and know how to calculate them
- Identify common cash-flow series
- Evaluate economic equivalence