Time Value of Money Paper

Essay by kls12974University, Bachelor'sA, March 2008

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Time value of money ("TVM") is defined as the idea that money available at the present time is worth more than the same amount in the future, due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received. TVM is also often referred to as "present discounted value" (Answers Corporation, 2006). TVM concepts help people like managers or investors understand the benefits and the future cash flow to help them determine if the future benefits will justify the initial cost of the project or investment. To recognize how annuities (a set of fixed payments over a specified length of time) affect the TVM, managers need to consider the factors of interest rates, opportunity cost, future and present values of the money, and compounding. In this paper, I will explain how annuities affect TVM problems and investment outcomes.

I will also address the impact of the following on TVM; interest rates and compounding, present value, opportunity cost, and annuities as well as the Rule of 72.

How do annuities affect TVM problems outcomes? Annuities are an investment that promise a constant amount of cash over a certain period. Since annuities generally gain interest, the organization receiving the payments is gaining interest. Annuities can be calculated differently based on the terms of the agreement between the two parties (Brealey, Myers, & Marcus, 2006).

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.