Time Value Of Money
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Intro
If I offered you million dollars today or in exactly one year from now, would you take the money now or wait? You would probably want the money now, and I would prefer you wait a year. Time value of money is the concept that an amount of money in ones possession is worth more than that same amount of money promised in the future. Today money can be invested to earn interest and therefore will be worth more in the future. Time value of money concepts helps a manager and/or investor comprehend the benefits and the future cash flow. This helps the manager and/or investor to make a decision if the future benefits will diminish the initial cost of the project or investment. In addition this paper will briefly address how annuities affect TVM problems and investment outcomes, interest rates and compounding, present value, future value, opportunity cost and also the Annuities and the Rule of 72.
How do annuities affect TVM problems outcomes?
The term annuity is used in finance to refer to any terminating stream of fixed payments over a specified period of time. Annuities are an investment that guarantees a steady amount of cash over a certain time period. And, since annuities generally gain interest, the organizations receiving the payments are gaining interests as well. Annuities can be calculated differently based on the terms of the agreement between the two parties.
How do annuities affect TVM investment outcomes?
Annuities affect TVM investments in a negative manner when the money is accumulating interest. If the money is paid with simple interest, the interest is calculated annually at the rate determined. If the interest is compounded, the interest is calculated annually on the existing balance and as the balance grows, so does the balance until the principle is paid down.
What is the impact of Interest Rates and Compounding on TVM?
When compounding periods are more frequent, interest is received more often, and therefore the potential value is greater. In addition, when analyzing, the greater the interest rate, the greater the return on investment. Both of these, interest rates and compounding periods, can quickly increase the rate at which an investment grows or a debt increases.
What is the impact of Present Value on TVM (of a future payment received?)
“Present value is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk. Present value calculations are widely used in business and economics to provide a means to compare cash flows at different times on a meaningful “like to like” basis”(Wikipedia 2007.) On hand money can be invested to earn interest. When payments are not received, cash flow is reduced and therefore interest earned is reduced. The greater the interest rate, the smaller the present value.
What is the impact of Future Value on TVM (of an investment?)
“Future value measures the nominal future sum of money that a given sum of money is “worth” at a specified time in the future assuming a certain interest rate; this value does not include corrections for inflation or other factors that affect the true value of money in the future”(Wikipedia