Essay: Time Value of Money
This is an essay on time value of money. For example if a dollar is invested today at 8% annual interest rate then at the end of the year the dollar would be $1.08.
For example if a dollar is invested today at 8% annual interest rate then at the end of the year the dollar would be $1.08. This would be the future value of the dollar. And the 8% interest would be the rate of return and the time period is one year. While the present value of $1.08 would be $1.
A lump sum future payments or equal sequential payments or receipts which are expected in future can be converted into a comparable value today. On the other hand the value of a single payment or annuities today can be calculated to be in future. The key components when evaluating the Time Value of Money are: (Gallager, 1996)
- The amount that is to be saved or invested which is called the present value of the sum to be invested
- The future value of the present amount would be sometime in future when the amount is compounded with a fixed interest rate. The future value is expected to be greater then the present value.
- Payments are the equal evenly-spaced cash flows from the investments.
- The rate of return on the principle which is called the interest rate which can be annual or semiannual or monthly usually stated as a percentage.
- The time period for which the money would be saved. This is not in terms of the number of years but in terms of the number of payments that would be made.
- There are different formulae to calculate the different values in TVM.
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