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Time Value Of Money Essay

1127 words - 5 pages

Time Value of Money: OverviewTime value of money is the concept that "an amount of money in one's possession is worth more than that same amount of money promised in the future." (Garrison, 2006) This paper will explain how annuities affect time value of money (TVM) and investment outcomes. "Today money can be invested to earn interest and therefore will be worth more in the future." (Brealey, Myers, & Marcus, 2004) In addition, this paper will briefly address the impact of discount and interest rates, present value, future value, opportunity cost and the impact interest has on money being borrowed.Time Value of MoneyPresent value is a current amount of money that is equivalent to a future payment or series of payments that has been discounted by an appropriate interest rate. The future amount can be a single sum that will be received at the end of the last period, as a series of equally spaced payments (an annuity), or both. Since money has time value, "the present value of a promised future amount is worth less the longer you have to wait to receive it." (Gallager&Andrew, 1996)Future ValueFuture value is the amount of money that an investment with a fixed, compounded interest rate will grow into by some future date. The investment can be a single sum deposited at the beginning of the first period, a series of equally spaced payments (an annuity), or both. Since money has time value, it is logically expected that the future value will be greater than the present value. "The difference between the two depends on the number of compounding periods involved and the going interest rate." (Gallager&Andrew, 1996) An annuity is a number of repeated payments or receipts in the same amount. Researchers propose that the annuity values happen at the end of each period. "Each TVM problem has five variables: interest rate or return, time or number of periods, future value, present value, and amount of payments either made or received." (Brealey, Myers, & Marcus, 2004)Borrowed FundsToday's lenders demand that interest be paid on borrowed funds as current dollars are lent out in anticipation of higher returns in the future. Part of the payments will go toward the payment of interest, with the remainder applied to reduce debt. It is presumed the borrower already knows the present value and wishes to determine what size annuity can be equated to that amount. We can use the time value of money to indicate the necessary payments on a loan. In other words, what annuity paid over "n" years is the equivalent of "n" dollars' present value with an "n" percent interest rate will the borrower needs to pay off the loan? In this case, we use the formula for determining the size of an annuity equal to a given present value.Saved FundsThe saver may also use TVM to determine how much money needs to be set aside each period to earn a certain return on the savings. In this case, the annuity equals a future value. For example, one might decide for retirement to...

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