In order to understand how to deal with money the important idea to know is the time value of money. Time Value of Money (TVM) is the simple concept that a dollar that someone has now is worth more than the dollar that person will receive in the future, this is because the money that the person holds today is worth more because it can be invested and earn interest (Web Finance, Inc., 2007). The following paper will explain how annuities affect TVM problems and investment outcomes. The issues that impact TCM will also be discussed: Interest rates and compounding (with two problems), present value, future value, opportunity cost, annuities and the rule of '72.
The idea of TVM allows managers or investors the capability to understand the advantages and future cash flow of the cost of an investment or project. TVM is an important concept in financial management. It can be used to compare investment alternatives and to solve problems involving loans, mortgages, leases, savings, and annuities (Getobjects.com, 2004).
"Interest is the cost of borrowing money. An interest rate is the cost stated as a percent of the amount borrowed per period of time, usually one year" (Getobjects.com, 2004). An interest rate is a very important factor in all financial decisions. The two types of interest rates are simple and compound (Brealey, Myers & Marcus, 2003). A simple interest rate for example, occurs when a person borrows money from a lender and he or she will have to pay the lender a fee, this fee is the simple interest rate (Brealey, Myers & Marcus, 2003). Simple interest is normally used for a single period of less than a year, such as 30 or 60 days [simple interest = p x i x n] (Getobjects.com, 2004). For example, a calculation for this problem would be: Say you borrow $50,000 for 60 days at 5% simple interest per year (assuming the year is calculated at 360 days per year). Interest = p x i x n = 50,000 x .05 x (60/360) = 416.667