Tag Archives: time value of money

Lesson 1: Time Value of Money

The climb up the rock face was tougher than you expected. Handholds were sparse and the ones you managed to find were sharp and jutted out at odd angles. You had to double back several times and find a new path up the mountainside. Now you feel a cold chill in the air and notice the sun beginning to sink behind the hills. Looking up, you spot a cutout in the rock face several yards away – it could be a cave. Half an hour later, your fingers grasp the edge of the cutout. Your muscles strain to pull your tired body inside. You roll onto your back and sigh heavily. Thankfully, it is a cave.

You awaken to the sound of birds tweeting. You sit up quickly and look around, your right hand instinctively gripping the hilt of your sword. You hadn’t meant to fall asleep at the mouth of cave. Luckily, you hadn’t rolled off in your sleep. You peer over the edge of the cliff to see how far you had climbed the day before. The ground is several hundred yards away, and you are rather pleased with yourself. Then you recall the instructions given to you by one of the elders of the nearby town. This might be the very cave that holds the rare treasure you seek. You whip out your torch and proceed into the depths of the cave.

After what seems like hours of walking, you reach what looks to be a dead end. You look back in the direction you came thinking you might have missed something. But then on closer inspection of the cave wall, you notice a small hole. You look through the hole, but it’s too dark too see anything. It could be an area that has been closed off, so you take your sword and drive it into the hole. The wall suddenly begins to crack and crumble. You kick and push your way through the rest of the broken wall and find yourself in an open cavern. The room is empty other than a reservoir of water in the middle. “This has to be it!” you think excitedly. You recall the elder’s words: Drink from the pool and a great power shall appear to aid you on your quest. As you stoop down to drink the water, you envision your dreams coming true.

The water is cool but tastes bitter, and as you’re drinking, a bright light suddenly flashes behind you. You turn to see a green fairy-like creature hovering a few feet in front of you.

“Hello! Did you summon me?” the creature chimes. You stare at the creature, confused. This couldn’t really be the great power the elder was talking about.

“I get that look a lot,” the creature says, “I know my incredible beauty can be perplexing at times. But don’t worry, young warrior, I have the ability to train you. You will achieve the Master level if you follow all of my instructions. By the way, I am Celia, your new mentor.” Celia hovers toward you, her wings flitting rapidly.

“You are a strong warrior physically, but intellectual strength is the more important factor in becoming a Master-level warrior. I’m going to teach you an advanced art that will boost your strength and give you the intellectual capacity to reach the Master level. It is called accounting.” Celia looks at you expectantly, but you’re not amused. Whatever accounting is, it sounds boring.

“The art of accounting will give you the information you need to make smarter decisions on and off the battlefield. You will be able to fight better and train smarter.” Celia pauses, and you shrug. She sighs and starts flying towards the cave exit.

“Where are you going?” you ask.

“Follow me”, she calls out and flits away into the dark.

After you have been walking for a few minutes, Celia stops abruptly in front of you. She waves her hand and a passageway opens in the wall. You follow the fairy through a corridor which spirals downward. It eventually leads you outside, back to the base of the mountain.

Celia turns toward you. “Alright, lesson one. I am going to teach you a powerful concept called the Time Value of Money.”

“The time val-what?” you question. Celia ignores you and continues, “The value of money changes with time. In other words, a dollar today has more value or is worth more than a dollar tomorrow.”

“How in the world is that possible?” you ask.

“I will give you an example to make it easier to understand. See those woods over there?” Celia points toward a small forest east of the mountain. “There are a group of goblins lurking in there waiting to kill and loot unsuspecting travelers. I want you to go defeat them.”

“Alright!” you shout excitedly and unsheathe your sword.

“But you have to give me your sword,” Celia replies.

“What?! Why?”

“Why does it matter? I’ll give you your sword later…” Celia responds calmly.

“But if I’m going to defeat the goblins, I’m going to need my sword now!” you argue frustratingly.

“Exactly!” Celia exclaims. “Do you value your sword more now or later?”

“Obviously now.”

“Yes, your sword is worth more now, because of what you can do with it now. You can’t kill goblins or gain experience now if you get your sword later,” Celia explains. “It is the same with the time value of money. Money is worth more today because of what you can do with it today. You cannot invest in something today with money that you can’t get until later.”

“I think I gained some intellectual XP.”

“Let’s go a little deeper,” Celia says. “You say that having your sword now is worth more than having it later. Well, let’s say we replace the sword you get later with a more powerful weapon, a battle axe. Would you rather have your sword now or the battle axe later?”

“I’m not sure,” you reply. “I really like having my sword now, but the battle axe is pretty cool.”

“Here is the point. Having your sword now is basically equivalent in value to the battle axe later. Why? Well, the extra power of the battle axe makes up for the fact that you can’t use it until later. With the time value of money, an amount that you can use now is considered equivalent to a larger amount that you can’t use until later.”

“I suppose that makes sense,” you say.

“It’ll make more sense as we continue to talk about it,” Celia replies encouragingly. “This next part is pretty straightforward. An amount of money that you can use or get today is a present value. An amount of money that you can’t use or get until later is a future value. For example, we could consider your current strength as a present value. It is the amount of strength you have available to utilize today. The strength that you will have in the future is a future value. You don’t have access to that strength yet, but you will.”

“Ok. I get it.”

“The difference between present and future value depends on how quickly money gains interest and how long it gains interest. The difference between your present strength and a future strength depends on how quickly you gain experience and how long you spend building the experience. As you defeat monsters and gain experience, your present strength increases and gets closer to a future strength.”

“Wow, this is kind of a lot,” you say, leaning against a nearby tree.

“I know,” Celia replies, “but I have now given you a valuable piece of the foundation you need to become a higher level warrior. You now understand that time changes the value of things. You understand the gap between your current and future strength. You understand that by increasing the rate at which you gain experience, you can reach Master level more quickly. You also know that to predict your future strength, you simply need to know your present strength, the length of time, and how quickly you will gain strength. In accounting, you understand the meaning of the time value of money. You also understand the relationship between present value and future value.”

Celia clapped her little green hands together. “Well, that’s enough for today. Tomorrow we will pick up your training where we left off. Until then, why don’t you go increase the rate of your experience by defeating some nearby monsters.”

“Do I get to use my sword?” you ask eagerly.

“Of course,” Celia chuckles.

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