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Time Value Of Money Application Essay

1092 words - 4 pages

An important concept in finance is time value of money which means that cash received at different times has different values. A dollar today is worth more than the same dollar tomorrow. Time value of money concepts helps a manager or investor understand the benefits and the future cash flow to help the manager or investor if the future benefits will justify the initial cost of the project or investment. In this paper we will identify and discuss how different business use this concept for the betterment of their business.Commercial banks:Commercial banks uses this concept of time value of money for the betterment of their business. One may wonder, " how does this process work?" commercial banks take deposits from individual and institutional customers, which they then use to extend credit to other customers. They make money by earning more in interest from borrowers of business loans, mortgages, auto loans, and home repair loans; than they pay in interest to those whose deposits they accept. (wet feet.com, internet) Banks also provide loans in the form of credit card charges, and render local services including safe deposit, notary, and merchant banking. Through this process Commercial banks in the U.S. earn 5 to 14 percent interest on most of their loans. As commercial banks typically only pay depositors 1 percent - if anything - on checking accounts and 2 to 3 percent on savings accounts, they make a tremendous amount of money in the difference between the cost of their funds (1 percent for checking account deposits) and the return on the funds they loan (5 to 14 percent). (college journal.com, internet)Credit card financial service companies:These companies uses the similar concept of time value of money to make money for themselves. Credit cards uses a simple terminology they provide convenience and allow you to make purchases with nearly a month to pay for them before finance charges kick in. The drawback is many consumers are unable to take advantage of these benefits because they carry a balance on their credit card from month to month, paying finance charges that can go up to a whopping 23 percent. The key to this is time value of money. If people pay off the credit card every month then they save the money. If not then the credit card have gained money by charging finance rate which is much higher than the inflation rate.Insurance companies:Insurance companies also uses this concept to benefit the business. Many people require insurance for different needs. The best example to understand what application of time value the insurance company use is the life insurance policy."The future value of money equation tells a person how much your money will be worth in a given number of years while earning a given rate of interest. This equation is essential if you are calculating how much money you'll need in the future because of inflation, or what your death benefit will be if you choose to invest the money at a given interest rate.The present...

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