...12/9/2012 Chapter 9 The Time Value of Money 1 Chapter 9- Learning Objectives Identify various types of cash flow patterns (streams) that are observed in business. Compute (a) the future values and (b) the present values of different cash flow streams, and explain the results. Compute (a) the return (interest rate) on an investment (loan) and (b) how long it takes to reach a financial goal. Explain the difference between the Annual Percentage Rate (APR) and the Effective Annual Rate (EAR), and explain when each is more appropriate to use. Describe an amortized loan, and compute (a) amortized loan payments and (b) the balance (amount owed) on an amortized loan at a specific point during its life. Principles of Finance 5e, 9 The Time Value of Money © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 2 1 12/9/2012 Time Value of Money The principles and computations used to revalue cash payoffs at different times so they are stated in dollars of the same time period The most important concept in finance used in nearly every financial decision Business decisions Personal finance decisions Principles of Finance 5e, 9 The Time Value of Money © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 3 Cash Flow Patterns Lump-sum amount – a single...
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...1. The four basic variables of the time value of money (TVM) equation are: FV = future value PV = present value r = interest rate, yield, discount rate or growth rate n = the time period between the present value and the future value These variables can be arranged in several ways to solve many questions about money. The most basic form of the equation is FV = PV x (1+r)^n Example: if I have $1,000.00 in my bank account today earning 5% interest for a period of 10 years, what is the future value? FV = 1000 x (1+.05)^10 = $1,628.89 When the interest (growth) rate increases, future value increases as well. Example: if I have $1,000.00 in my bank account today earning 10% interest for a period of 10 years, what is the future value? FV = 1000 x (1+.10)^10 = $2,593.74 Discount rate is the opposite of growth rate. When the discount rate increases, present value decreases. 2. A series of payments can be described as making payments at regular intervals in varying amounts. In other words, if I make payments to a creditor on the 5th day of every month for 1 year, with each amount being different depending on my purchases that month, I am making a series of payments. An annuity, on the other hand, is a series of equal payments at regular intervals. If I make all my payments for $100.00 to a creditor on the 5th day of every month, this is considered an annuity. These are typically found in contractual obligations or other similar legally binding agreements...
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...Abstract In this paper, Team C will discuss the concept of the time value of money and the importance of this concept in business. Also, we will provide a demonstration of the use of the formula used to calculate the present and future values of money to get the present value of $100 using different periods of time and interest rates. Time Value of Money In the world of business, it is essential to know what TVM represents and how it helps make better choices in how we spend our money. TVM is also known as Time Value of money which is a given amount of interest earned in a period of time (Wikipedia, 2011). Each member in group “C” will use 100 as our present value and we will choose an interest rate and period. Time value of money concept is used to determine present and future values of money. “The time value of money refers to the relationship between time, money, and the rate of interest.” (Letsche, 2011). The formula consist of four components FV = Future Value, PV = Present Value, i = the interestrate per period and n= the number of compounding periods (TeachMeFinance.com). In business, TVM is used to evaluate expected returns on investments and monitoring the company’s cash flow. “However, understanding the time value of money is also very important for you as an self-employed business person to make sure you are able to realize your spending, purchasing and retirement goals.” (Loughran, 2011). On a personal level, individuals can use TVM to calculate interest...
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...Time Value of Money Managerial Finance II/FIN476 October 21, 2007 Time Value of Money The Time Value of Money (TVM) serves as a foundation for all other notions in finance. It influences business finance, consumer finance and government finance. Time Value of Money (TVM) results from the concept of interest. Time Value of Money (TVM) is an important concept within the financial management. It compares investment alternatives and then to solve problems, which involving loans, mortgages, leases, savings, and annuities. “In determining the future value, we measure the value of an amount that is allowed to grow at a given interest rate over a period of time” (Block & Hirt 2005). “Why would any rational person defer payment into the future when he or she could have the same amount of money now? For most of us, taking the money in the present is just plain instinctual. So at the most basic level, the time value of money demonstrates that, all things being equal, it is better to have money now rather than later” (Croome 2003). The concept of Time Value of Money (TVM) is that the dollar that company has today is worth more than the promise or expectation that the company will receive a dollar in the future. Money, which a company holds today, is worth more because the company can then invest it and earn interest. Therefore, a company should receive some compensation for foregoing spending. For instance, a company can invest their dollar for one year at...
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...Introduction The time value of money concept is fundamental to the analysis of cash inflow and outflow decisions covering periods of over one year. Additionally, the concept of time value of money is important to financial decision-making because it emphasizes earning a return on invested capital, recognizes that earning a return makes $1 worth more today than $1 received in the future and it can be applied to future cash flows in order to compare different streams of income. A dollar to be paid or received in different time periods will have different values. For instance, a dollar today is worth more than a dollar in two years from now. This is because we can invest the dollar today, which will earn us a rate of return (interest) and create an increased value in two years. This process is called compounding and it involves taking a dollar today (present value), and investing it so that it grows into a larger amount in the future (future value). Additionally, managers must also understand factors which affect time value of money such as annuities which could include interest rates, opportunity costs, future and present values of money, and compounding. According to Brealey, Myers & Marcus, 2004, “each time value of money has five variables: interest rate or return, time or number of periods, future value, present value, and amount of payments either made or received” (pg. 812). The two key components of time value of money are present value (PV) and future value (FV). Present...
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...Time value of money is the concept that shows the value of money which decreases day by day. There are so many factors which contribute to the time value of money such as inflation and increasing interest rates. The time value of money is sued to solve the problems which are related to the loans, mortgage, leases, saving and annuities. In the investment, time value of money is used to compare the alternatives of investment (Weil, 1990). The time value of money is based on the concept that money that anyone has today is worth more than the expectation which one will receive in the future. The money which is hold in the present is worth more because it can be invested and can earn the interest. For example, one can invest the dollar for one year at a 6% annual interest rate and accrue &1.06 at the end of the year. Then it can be said that the future value of the dollar is $1.06 given an interest rate and the present value of the $1.06 it is expected to receive in one year is only $1 (Drake, & Fabozzi, 2009). Interest rates and series of payments are included in the transactions. If the time value money is not used in past then there may be risk in the transaction. This helps in reaching at the comparable value of the money. that anyone has today is worth more than the expectation which one will receive in the future. The money which is hold in the present is worth more because it can be invested and can earn the interest. For example, one can invest the dollar for...
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...Time Value of Money I recently opened a Roth IRA account in 2014. Being in my 30’s already, I got started a tad bit late but nonetheless I’m planning for my retirement now. My main focus is to maximize contribution each year and allow for it’s steady growth so that I can afford to sustain my lifestyle after I retire. I plan to save at least a million dollar for my retirement. Although there are not any tax deduction provisions for Roth IRA, the earnings are tax-free. So, in the long run it will be beneficial, as I don’t have any plans to withdraw the money until I retire. I opened the Roth IRA account with $3500 at the end of 2014 at the age of 30. I intend to contribute $3500 at end of every year till the age of 65 years, which will be my retirement age. The annual expected return from investment is 7%. Since, I will be making a series of equal payments at fixed intervals for a specified number of time and doing it at the end of every year, the future value will be- PMT= $ 3500 I=7% N=35years FVA=? FVA=PMT [(1+I)^N-1÷I] FVA= 3500[(1+0.07)^35-1÷0.07] = $483829.10 So, if I stick to my current plan, I will only be able to save $483,829 at the age 65. Lets assume if I fulfill the maximum contribution of $5500 each year with same expected annual return of 7%, then my savings will be- PMT= $ 5500 I=7% N=35years FVA=? FVA=PMT [(1+I)^N-1÷I] FVA= 5500[(1+0.07)^35-1÷0.07] = $760302.83 It looks like although I make maximum contribution each year, I won’t...
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...TIME VALUE OF MONEY Future Values and Compound Interest Interest is the price paid for the use of borrowed money You have $100 invested in a bank account. Suppose banks are currently paying an interest rate of 6 percent per year on deposits. So after a year, your account will earn interest of $6: Interest = interest rate × initial investment = .06 × $100 = $6 You start the year with $100 and you earn interest of $6, so the value of your investment will grow to $106 by the end of the year: Value of investment after 1 year = $100 + $6 = $106 Notice that the $100 invested grows by the factor (1 + .06) = 1.06. In general, for any interest rate r, the value of the investment at the end of 1 year is (1 + r) times the initial investment: Value after 1 year = initial investment × (1 + r) = $100 × (1.06) = $106 What if you leave this money in the bank for a second year? Your balance, now $106, will continue to earn interest of 6 percent. So Interest in Year 2 = .06 × $106 = $6.36 You start the second year with $106 on which you earn interest of $6.36. So by the end of the year the value of your account will grow to $106 + $6.36 = $112.36. In the first year your investment of $100 increases by a factor of 1.06 to $106; in the second year the $106 again increases by a factor of 1.06 to $112.36. Thus the initial $100 investment grows twice by a factor 1.06: Value of account after 2 years = $100 × 1.06 × 1.06 = $100 × (1.06)2 = $112.36 If you keep your money invested for a...
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...Time Value of Money: Name: Professor’s Name: Institution: Course Title: Date: Introduction Time Value of Money is the concept that a certain amount of money has a different value today than it would in the future. It is explained as the idea that money at hand at the present time is worth much more than the equal amount would in future (Crosson, 2008). If you lend your friend money today, most likely he will refund the same amount you lend him in future. That money will have added no value to itself. Lending it to your friend is not an investment. The sooner you get the money back, the better because you can invest it elsewhere. Therefore, if one was not to use a given amount of money today, with intentions of using it in the future, he should put that money in a saving account. That way, the money will accrue interest and it will not be of the same amount as initially saved. The amount of interest accrued on saved money depends on three things: the initial amount saved, the bank interest rate and the span of time the money will be saved. Inflation is another factor to be considered when calculating the interest to be accrued. If the inflation is high, the interest reduces since the ‘value’ of money reduces (Carr, 2006). This paper will discuss this concept of time value of money with the help of a question problem. Assuming I am 30 years old plans and I plan to accumulate $1 million by my retirement date, which is 30 years from now...
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...Time Value of Money: Simple Interest versus Compound Interest Outline I. Applications of Time Value of Money 1.1 Example One 1.2 Example Two 2. Interest 2.1 What is Interest? 2.2 Three Variables of Interest 1. Principal 2. Interest Rate 3. Time 2.3 Why is Interest Charged? 3. Simple Interest 3.1 What is Simple Interest? 3.2 Simple Interest Formula 4. Compound Interest 4.1 What is Compound Interest? 4.2 Compound Interest Formula 5. Compound Interest Tables 1. Future Value of $1 2. Present Value of $1 3. Present Value of an Ordinary Annuity of $1 4. Present Value of an Annuity due 5. Present Value of a Deferred Annuity 6. Conclusion 7. References Abstract The time value of money (TVM) is based on the principle that "a dollar today is worth more than a dollar in the future, (Mott, 2010, pp.31). Waiting for future dollars involves a cost -the cost is foregoing the opportunity to earn a rate of return on money while you are waiting" (pp.31). TVM was developed by Leonard Fibonnacci in 1202 and is one of the basic concepts of finance. One hundred dollars today has a different buying power than it will have in the future. For example, $100 invested in a savings account at your local bank yielding 6% annually will grow to $106 in one year. The difference between the $100 invested now-the present value of the investment-and its $106 future value represents the time value of money, (Spiceland...
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...TIME VALUE of MONEY Exercises Author: Luigi V. TAVA Copyright SDA Bocconi revised 2004.10 EMQ 901 1 1) For a loan of 9.2 estimate the future refund value (principal, interest, total) with simple interest: a) yearly rate 5%, for 6 years and 4 months b) yearly rate 8%, for 7 years, 2 months and 15 days 2) With a starting investment of 3.65 how long does it take to have a final total value of 4.779 with a 5.2% yearly rate, simple interest ? 3) 10 years ago you deposited 15.6 in a bank account paying 5% (yearly compounding). Six years ago you withdraw 8.465 from the same account and reinvested the same amount at 7.25% (yearly) How much is available now (total)? 4) 3 years ago your parents opened a “saving account” in your favour with a bank paying a 10.75% yearly interest rate. How much do you own today for each € deposited? 5) You borrow, as an overdraft on your current account, 50 with an Italian bank charging you a nominal yearly rate of 18%. How much is your debt with the same bank two years later (Italian banks use Nominal Rates convertible quarterly)? 6) You are entitled to receive 100, 3 years from now. What is the present value of your credit discounted at 16% yearly rate? 7) Your bank charges a 16% yearly nominal rate (quarterly compounding) for a loan in your current account; how much will you pay after 3 years for a 400 loan? 8) How much do you have to invest to have 50 after 4 years with a 12% yearly return? 9) An initial bank deposit of 10 is equal to 50 after...
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...Time Value of Money Table of Contents Abstract………………………………………………………………………………3 Time Value of Money………………………………………………………………..4 Future Value and Present Value…………………………………………………......5 Challenges…………………………………………………………………………...6 Summation…………………………………………………………………………..8 References…………………………………………………………………………...9 Abstract Time value of money operations are the backbone of financial decisions in business. The basics of their operation lie in interest calculations that can be used to determine the value of money five years ago, today and even well into the future. These calculations can be tricky and are weighed with outside challenges that can affect them positively and negatively and give a good framework of when, where and how money should be invested and capital allocated. Time Value of Money It is generally stated that money today is worth more than the money of tomorrow. This simple statement of finance is the basis for understanding the time value of money and how it relates to opportunity costs, sunk costs, present and future values and discount rates. (Wilson, 2010). There are many factors which affect money, but predominantly inflation, risk, and opportunity loss are the factors which affect the time value of money and are the influences which directly affect a manager’s ability to understand and use financial information relating to present and future values to make sound decisions. Future Value (Fv) and Present Value (Pv) In economics, the time value...
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...Believe it or not many people through out the years thought that by putting money to the side, under the mattress or, even in the cookie jar that eventually one day they would be rich. Well not to spoil the surprise but the years it would take to make one rich by those means are far off and nothing in between. This is where Time Value of Money comes in. Time Value of Money is the idea that a dollar today is worth more than a dollar in the future, even after the adjustments of inflation, interest rates, and appreciation until the time come for the dollar in the future to be received. Simply stated invest. There are a variety of financial applications of the time value of money. This paper will identify different financial application, and components of a discount and interest rate. The goal is to list various financial applications, and explain the components of discount and interest rates. Financial Applications The time value of money can be applied to many everyday financial decisions. Suppose a parent wants to set aside present funds for their child’s educational future. Several factors will impact the ability to yield a return, such as the number of periods involved and the applied interest rate. For this reason, the concept of the time value of money can be calculated by several financial applications. The financial applications consist of future values and present values, annuity, and yield of an investment, which will be...
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...3. Time Value of Money II- tutorial questions (tutorial in week 4) | 1. You are in first year at university and are planning a trip to Vietnam when you graduate at the end of 4 years. You plan to save the following amounts annually, starting today: $625, $700, $700 and $750. If the account pays 5.75 per cent annually, how much will you have at the end of 4 years? 2. Stephanie Watson plans to adopt the following investment pattern beginning next year. She will invest $3125 in each of the next 3 years and will then make investments of $3650, $3725, $3875 and $4000 over the following 4 years. If the investments are expected to earn 11.5 per cent annually, how much will she have at the end of the 7 years? 3. Arian Motavalli borrowed a certain amount from his friend and promised to repay him the amounts of $1225, $1350, $1500, $1600 and $1600 over the next 5 years starting at the end of the first year. If the friend normally discounts investments at 8 per cent annually, how much did Arian borrow? 4. Dynamic Telecommunications Ltd has made an investment in another company that will guarantee it a cash flow of $22 500 each year for the next 5 years. If the company uses a discount rate of 15 per cent on its investments, what is the present value of this investment? 5. Cecelia Yeung is a sales executive at a Brisbane company. She is 25 years old and plans to invest $3000 every year in a retirement savings account, beginning at the end of this year until she turns...
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... 3. Now change the interest rate to a lower rate. How much will you have at the end of four years if interest is compounded annually at a rate of 2%? How much would you have at the end of four years if interest is compounded semiannually? If you used a lower rate of 2% and compounded annually you would have $ 5,412.16. If you compounded the interest semiannually with the same rate you would have $ 5,414.28. 4. You have $10,000 in credit card debt, at a 14% interest rate. When is it beneficial to pay off the debt vs. putting money in a savings account? Explain the pros and cons of either option. A benefit of paying off the debt is that you will not have to keep paying finance charges. For example a $ 10,000 debt with a 14% interest rate will cost you $ 6,889.60 in interest over the course of a four year term. One benefit to paying these charges if you pay them on time it will help your credit score stay higher. One benefit to putting your money in a savings account is that it is safer there in the account. I would have to say that one of the cons of...
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