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The Concept Of Time Value Of Money

956 words - 4 pages

Show Me the MoneyThe concept of Time Value of Money (TVM) is that a dollar in ones hand is more valuable than receiving that same dollar in the future because of the potential earnings of the money in ones possession when invested properly (University of Phoenix, 2007). TVM has factors that can assist in determining whether money should be held on, invested or spend. This paper will define the factors that include opportunity cost, interest rate, compounding, present value and future value, and their impact on TVM. This paper will also address how annuities and Rule 72 affect TVM problems and investment outcomes.Impact on Opportunity CostOpportunity cost is the cost of given something up or forfeited to get something else (Opportunity Cost, n.d.). A company's sales and gross margins are important to its success but its cash flow investments are also important. TVM is evident in opportunity cost when a company evaluates future investments of its cash flow with a desired result of increasing the value of its current funds at the time the maturity or liquidation of the investment. These cash flow investments must be carefully analyzed if an investment is worth the risk because a poor decision may tie up an organization's money or worse its cash flow may be put at risk.Impact of Interest Rates and CompoundingInterest rate is the either cost or return stated as a percent of the borrowed or invested money per specified period, typically one year (Interest, n.d.). "Compound interest is calculated each period on the original principal and all interest accumulated during past periods. Although the interest may be stated as a yearly rate, the compounding periods can be yearly, semiannually, quarterly, or even continuously." (Interest, n.d, found in the Compound Interest section, para 1). In simple terms, compound interest is a succession of back-to-back earned interest. Interest rate and compound interest are the biggest factors which impacts TVM because these two factors are primarily used to calculate if an investment's future payout has enough value to cover the duration of the funds being tied up.Impact of Present and Future Value"Future Value is the amount of money that an investment made today, present value, will grow to by some future date. Since money has time value, we naturally expect the future value to be greater than the present value." (Present Value, n.d, found in the Future Value of a single amount section, para 1). A good example of present and future value is investing $100 in 2007 which will yield a 5% annual interest rate is worth more than receiving that same $100 in 2008. The $100 invested in 2007 is the present value, and the future value in 2008 will be $105. Where the future value of $100 received in 2008 will be $95.Present and future value is a tool used by organizations to determine the payout of investment, and it provides justification of extending discounts to customers for early payment. Present and future value is also...

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