Time Value of Money

Essay by bakerboobooUniversity, Bachelor's February 2008

download word file, 3 pages 3.5

TMV is an important concept in the financial industry. The time value of money concept is based on the idea that money received now will be worth more than money received at a later time. This is so due to the fact that money in the hand now can be invested immediately and can earn interest as opposed to money that is received in the future, which has earned no interest. The contents of this paper will explain the how annuities affect TVM problems and investment outcomes by addressing the impact of interest rates and compounding, present value, future value, opportunity cost, and annuities and the rule of '72 on TVM.

Impact of TVMInterest rate is a price charged, usually yearly, by a lender to a borrower in order to obtain a loan (Moffat, 2007). According to Little compounding happens when "interest is earned on the principal during one period, and then the next period interest is earned on the resulting principal plus interest in the first period" (2007, para.

1). Compounding is basically interest earning interest. The impacts that interest rate and compounding has on TVM is that these two factors have the ability to increase the rate of investment growth or can increase the amount of debt. Interest rates In addition more or frequent periods of compounding will mean more interest is being generated and this leads to an increase of the future value. Another impact interest rates and compounding has on TVM is that interest rates and compounding are commonly used to determine whether the payout of an investment is valuable enough to make up for the funds that are tied up.

Present Value and Future ValuePresent value is the current value, or the value today of future cash flow (Brealey et al., 2007). Future value is...