Time Value of Money

Introduction
Time Value of Money (TVM) is an important concept in financial management. It can be used to compare investment alternatives and to solve problems involving loans, mortgages, leases, savings, and annuities.
TVM is based on the concept that a dollar that you have today is worth more than the promise or expectation that you will receive a dollar in the future. Money that you hold today is worth more because you can invest it and earn interest. After all, you should receive some compensation for foregoing spending. For instance, you can invest your dollar for one year at a 6% annual interest rate and accumulate $1.06 at the end of the year. You can say that the future value of the dollar is $1.06 given a 6% interest rate and a one-year period. It follows that the present value of the $1.06 you expect to receive in one year is only $1.
Ever wondered how the value of money grows when invested and falls when not invested? Here comes the concept of time value of money. A rupee today is more valuable than a rupee a year after. This is so because, in such an inflationary period a rupee today represents a greater real purchasing power than a rupee a year after. Also rupee earned today can be employed productively to generate positive returns.

Let us see this by a simple illustration -
Assuming a 5% interest rate, Rs. 100 invested today will be worth Rs. 105 in one year (Rs100 multiplied by 1.05). Conversely, Rs100 received one year from now is only worth Rs. 95.24 today (Rs100 divided by 1.05), assuming a 5% interest rate.
This is how your money grows when invested and degrades when not invested. Now when it is invested, see the difference of earning between interest earned on simple interest method and that earned on compound interest method.

To make it simpler see the diagram:-