Time Value of Money Paper

1410 Words Jun 19th, 2007 6 Pages
Time Value of Money Paper In order to understand how to deal with money the important idea to know is the time value of money. Time Value of Money (TVM) is the simple concept that a dollar that someone has now is worth more than the dollar that person will receive in the future, this is because the money that the person holds today is worth more because it can be invested and earn interest (Web Finance, Inc., 2007). The following paper will explain how annuities affect TVM problems and investment outcomes. The issues that impact TCM will also be discussed: Interest rates and compounding (with two problems), present value, future value, opportunity cost, annuities and the rule of '72. The idea of TVM allows managers or investors the …show more content…
Although the interest may be stated as a yearly rate, the compounding periods can be yearly, semiannually, quarterly, or even continuously" (Getobjects.com, 2004). So in order to understand this, another problem can be solved: $50,000 is borrowed for two years at 6% annual interest.
Interest year 1 = p x i x n = $50,000 x .06 x 1 = $3,000
Interest year 2 = (p1 + i1) x i x n = ($50,000 + $3,000) x .06 x 1 = $3,180
The total compounded interest over two years is $3,000 + $3,180 = $6,180. Money has a time value and the value today of future cash flow is referred to as the present value (Brealey, Myers & Marcus, 2003). The present value of a future amount is worth less the longer one waits for it (Brealey, Myers & Marcus, 2003). "The future value is the amount of money that an investment made today (the present value) will grow to by some future date. Since money has time value, we naturally expect the future value to be greater than the present value. The difference between the two depends on the number of compounding periods involved and the interest (discount) rate" (Getobjects.com, 2004). In order to calculate each of these two formulas can be used: PV = FV [ 1 / (1 + i)n ] for present and FV = PV (1 + i)n for future; FV = Future Value, PV = Present Value, i = Interest Rate Per Period, and n = Number of Compounding Periods (Getobjects.com, 2004). Once the

Related Documents