Time Value of Money



1) Time Value of Money

The concept of time value of money is associated primarily with such financial categories as the cost of the loan or the cost of equity. Hence, the main idea is that the money that is available now will worth more in the future due to the possible earning capacity. The principle which holds this concept is the interest that is earn on the invested amount (Smal C., 2001).

For instance, assume 10% interest rate; $100 invested today will be worth $110 in one year i.e. $1000 multiplied by 1.1. On the other hand, one year from now $1000 will be received which is value $95.24 today ($100 divided by 1.1). Through time value of money, one can calculate the following four values:  

Future Value of a Dollar calculation (FV$)

Present Value of a Dollar calculation (PV$)

Future Value of an Annuity (FV of Annuity)

Present Value of an Annuity (PV of Annuity)  

(2) Importance of Time Value of Money for Financial Managers

It is importance for the financial manager to understand the concept of the time value of the money in order to make and compare the investment alternatives and hence to solve the problem that arises in loans, mortgages, leases savings and annuities. In doing financial analysis regarding the decision making which impact on the cash flows of the company, it is necessary for the manager to convert the comparable amount of cash which will arrive in future or different maturity times. In order to determined their values for the same period. Cash flow, return rates, and property value, finance, and a few tens of rates and other measures are not better or worse than the final result.

In summary, manager must involve the time value of money because any cash flow expected to occur in the future may not be worth the amount you think. Time value of money is the concept of measuring the value of money over time. The idea is clear and direct because the money is still consistent and more of the value of the changes which time is measured, it must be against time. For example: The same costs that arise in different periods are not entirely comparable to each other, it allows to carry out all financial analysis through which the results are reliable and from which the manager can make responsible decisions. The manager is also able to accurately determine the actual costs of borrowings, loans and other payments (Scott D, Moore W. 2007).

3) Calculate the future value of the following

$54298 if invested for five years at a 7% interest rate

FV = 54298 (1+ 0.07)5

FV = 54298 (1.07)5

FV = 76155.8 dollars

$99,112 if invested for three years at a 4% interest rate

FV = 99,112 (1+ 0.04)3

FV = 99,112 (1.04)3

FV = 111487.5208dollars

$121,124 if invested for seven years at an 2% interest rate

FV = 121,124 (1+ 0.02)7

FV = 121,124 (1.02)7

FV = 139133.4028 dollars

$929,129 if invested for ten years with a 0.9% interest rate

FV = 929,129 (1+ 0.009)10

FV = 54298 (1.009)10

FV = ...