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Time Value of Money

By snk871 Sep 17, 2012 1020 Words
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 that will be paid on mortgages, car payments and individual loans. Knowing how your money can work for you is important to personal financial success. When one considers the time value of money it is important to understand that “a dollar can be invested and earn interest over time” (Myers, 2011). Time value of money is a very important concept in the role of investing money. This would be because, “it explains the concept of compound returns, which causes investments to grow exponentially over time” (The Time Value of Money, 2007). When one decides to invest in a company or product they are essentially looking for what would yield them the most profit. With that being said if one can understand the time value of money then it is possible to understand the expected and actual return of an investment. Thus with the knowledge of time value of money one can project an estimated return which is close to their actual profit. As a result of the potential earning capacity, money at the available time is worth more than the same amount in the future (Investopedia). Due to this, time value of money is also known as “present discounted value.” Some factors such as inflation and different interest rates play a role in the value of money over time. Business managers can benefit a great deal in knowing what the value of money is in a certain time based on these interest rates. Understanding the value of money at the present time versus in the future allows for better investment opportunities that offer better returns for a company (QFinance). Using the following formula: FV * (1/((1+i)^n)) = PV, we will demonstrate how TVM calculations inform us about what a future value of $100 will be in the present based on different time periods and interest rates. In the above formula “FV” is the future value, “PV” is the present value, “i” is the interest rate, and “n” is the number of periods (Voidware.com) •15 years at 3% Interest

The present value of $100.00 at 3% in 15 years
FV * (1/((1+i)^n)) = PV
100 * (1/ ((1+.03) ^15 = PV
100 * (1/ (1.5579674166) = PV
100*(0.6418619473 = PV
PV = $64.18
9 years at 10% Interest
The present value of $100.00 at 10% in 9 years
FV * (1/((1+i)^n)) = PV
100 * (1/ ((1+.1) ^9 = PV
100 * (1/ (2.357947691) = PV
100*(0.424097618) = PV
PV = $42.41
20 years at 6% Interest
The present value of $100.00 at 10% in 9 years
PV= 100(1/((1+ 6/100)^5)
PV=100 (1/((1+0.06)^5)
PV=100 (1/((1.06)^5)
PV=100 (1/1.3382)
PV = $74.72
10 years at 7% Interest
The present value of $100.00 at 7% in 10 years
PV = FV*(1/((1+i)^n))
PV = 100*(1/(1+0.07)^10))
PV = 100 *(1/1.967151357)
PV = 100 * 0.508349292
PV = $50.83

The Time Value of money is an important concept for businesses to understand because it helps business managers understand the value of money at different periods of time based on different interest rates. It helps them in their investment planning and helps in giving an idea of when an investment is worth it or not. Using the formula from above, the present value, future value, and the interest rate can be calculated based on what it is that the person using the formula is looking for. A good understanding of the time value of money, a company can better control their finances.

References
1.Letsche, Anna. (February 18, 2011). “Entension Educator-Family & Consumer Sciences, Day County. 2.Loughran, Marie. (2011). “Understanding the Time Value of Money” 3.Investopedia® (2011). Retrieved from: http://www.investopedia.com/terms/t/timevalueofmoney.asp#axzz1f4aCIOV4 4.Wikipedia. (2011). Retrieved from http://en.wikipedia.org/wiki/Time_value_of_money 5.TeachMeFinance.com . (n.d.). Retrieved from http://teachmefinance.com/timevalueofmoney.html 6.The Time Value of Money. (2007). Retrieved November 28, 2011, from Your Complete Guide to Investing in Mutual Funds: http://www.investing-in-mutual-funds.com/time-value-of-money.htm 7.Myers, D. (2011, January 22). Time Value of Money: Determining Your Fiture Worth. Retrieved November 28, 2011, from Investopedia: http://www.investopedia.com/articles/fundamental-analysis/09/net-present-value.asp#axzz1f3YnA3ov 8.QFinance (2011), Time Value of Money. Retrieved from: http://www.qfinance.com/cash-flow-management-calculations/time-value-of-money 9.Voidware, TVM Calculations. Retrieved from:

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