Which of the following best describes the time value of money?

• A. A dollar received today is worth more than a dollar received in the future due to its earning potential.
• B. Future cash flows are always discounted at the same rate as past cash flows.
• C. Money loses value over time only because of inflation.
• D. The value of money remains constant regardless of when it is received.

Answer: (A)

Verified step by step guidance

1. Understand the concept of the time value of money (TVM): The time value of money is a fundamental financial principle that states a dollar received today is worth more than a dollar received in the future. This is because money has the potential to earn returns (e.g., through investments or interest).
2. Analyze the first statement: 'A dollar received today is worth more than a dollar received in the future due to its earning potential.' This aligns with the TVM principle, as it highlights the earning potential of money over time.
3. Evaluate the second statement: 'Future cash flows are always discounted at the same rate as past cash flows.' This is incorrect because discount rates can vary depending on factors such as risk, inflation, and market conditions.
4. Evaluate the third statement: 'Money loses value over time only because of inflation.' This is partially true, but it oversimplifies the concept. While inflation does erode purchasing power, the time value of money also considers the opportunity cost of not investing or earning returns on money.
5. Evaluate the fourth statement: 'The value of money remains constant regardless of when it is received.' This is incorrect because it contradicts the TVM principle, which states that the value of money changes over time due to earning potential and other factors.