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Time Value Of Money Application Paper

1168 words - 5 pages

IntroductionAn important concept in finance is time value of money (TVM), which means that cash received at different times has different values. A dollar today is worth more than the same dollar tomorrow. TVM concepts help 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, I will identify and discuss how different businesses use this concept for the betterment of their business. (Moyer, 1998)Commercial banksCommercial banks use the concept of TVM for the betterment of their business. Commercial banks take deposits from individual and institutional customers, which the bank then uses to extend credit to other customers. They make money by earning more in interest from borrowers of business loans, auto loans, mortgages, and home repair loans than they pay in interest to those whose deposits they accept. (Block and Hirt, 2002) Banks also render local services including notary, safe deposit boxes, and merchant banking as well as provide loans in the form of credit card charges.Through this process, Commercial banks make a tremendous amount of money in the difference between the costs of their funds. Banks earn 5 to 14% interest on most of their loans and only pay depositors 1%, if anything, on checking accounts and 2 to 3% on savings accounts. (College Journal, 2007)Credit card financial service companiesThese companies use the similar concept of TVM to make money for themselves. Credit cards use a simple terminology they provide convenience and allow the consumer 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 pay finance charges when they carry a balance on their credit cards each month, which can go up over 32%. The key to this TVM is, if people pay off the credit cards every month then they save the money on finance charges, and if not then the credit card companies have gained money by charging finance charge, which is much higher than the inflation rate. (Block and Hirt, 2002)Insurance companiesInsurance companies also use this concept to benefit the business. Many people require insurance for different needs. The best example to understand what application of TVM the insurance companies 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 will 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 value of money equation tells you what your money is worth before it has been invested for a given number of years at a given rate of interest. This is important if you have an amount of...

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