Time Value of Money
Introduction
The time value of money is an important concept in financial management. It can be used to compare investment alternatives and to solve problems involving loans, mortgages, leases, savings, and annuities. The time value of money can be defined as the value of money received today instead of in the future. This is based on the premise that cash in hand today is more valuable than the same amount in the future due to its capability of earning interest. For investors, this is single most important concept in the world of finance. This paper will discuss the different financial applications of the time value of money. This paper will also describe the components of interest and highlight various methods of calculating time value of money using different interest scenarios.
Financial Applications of the Time Value of Money
Time value of money has many useful applications. One of the most important uses is that it helps to measure the trade-off in spending and saving. This can have important consequences for your personal budgeting. If market interest rates are at 5%, one may decide that the time value of money is greater in the future, and decide to invest. If rates are a meager 2%, it is easy to decide that the time value of money is higher today, and choose to spend.
In other words:
1. Is it profitable to borrow in order to invest?
2. Is a loan with a lower interest rate always best?
3. What do I need to invest right now at 8% interest in order to have $1,000,000 in 20 years?
The basic notion behind the time value of money is that a dollar received today is worth more than a dollar received tomorrow. An important caveat to this concept is that a dollar received today could be invested in order to increase its worth and purchasing power. The earlier a dollar is received, the earlier it can be put to work in the capital and financial markets to increase cash flows and net worth.
Companies, governments and individuals all compete for funds in the
The time value of money is an important concept in financial management. It can be used to compare investment alternatives and to solve problems involving loans, mortgages, leases, savings, and annuities. The time value of money can be defined as the value of money received today instead of in the future. This is based on the premise that cash in hand today is more valuable than the same amount in the future due to its capability of earning interest. For investors, this is single most important concept in the world of finance. This paper will discuss the different financial applications of the time value of money. This paper will also describe the components of interest and highlight various methods of calculating time value of money using different interest scenarios.
Financial Applications of the Time Value of Money
Time value of money has many useful applications. One of the most important uses is that it helps to measure the trade-off in spending and saving. This can have important consequences for your personal budgeting. If market interest rates are at 5%, one may decide that the time value of money is greater in the future, and decide to invest. If rates are a meager 2%, it is easy to decide that the time value of money is higher today, and choose to spend.
In other words:
1. Is it profitable to borrow in order to invest?
2. Is a loan with a lower interest rate always best?
3. What do I need to invest right now at 8% interest in order to have $1,000,000 in 20 years?
The basic notion behind the time value of money is that a dollar received today is worth more than a dollar received tomorrow. An important caveat to this concept is that a dollar received today could be invested in order to increase its worth and purchasing power. The earlier a dollar is received, the earlier it can be put to work in the capital and financial markets to increase cash flows and net worth.
Companies, governments and individuals all compete for funds in the