Effect of Time Value of Money?

Question

Can someone tell what the effect of the Time Value of Money is on Compounding?

Answer 1

The time value of money is the interest someone pays to borrow the money. Compounding means that you make interest not only on the principal amount (the original amount, let's say $100) but also get interest on the interest earned earlier. Here is an example:

Now  $100

1 year $ 100 + $5 interest=$105

2 years $105 + $5.25 interest (5% x 105) = $110.25

3 years $110.25 + 5.52 interest (5% x 110.25) = $115.77

4 years $115.77 + 5.78 interest (5% x 115.77) = $121.60

and so on