module 3 finance
mickey1995
mschumacher_module2finance_083020.pptx
Presented By: MiKayla Schumacher
Presentation Date: August 30, 2020
Time Value Of Money Idea
Time value of money refers to the idea in which the money which is available at the present time is actually worth more than the same amount in the future because of its potential earning capacity. This is an important finance principle which holds that; provided money can earn interest, any amount is usually worth more the sooner it’s received.
Time value of money refers to the idea in which the money which is available at the present time is actually worth more than the same amount in the future because of its potential earning capacity. This is an important finance principle which holds that; provided money can earn interest, any amount is usually worth more the sooner it’s received.
This Time Value of money idea is important to the investors since it can be utilized in comparing investment alternatives as well as solving problems that tends to involve loans, leases, as well as savings. Therefore to investors specifically, the TVM helps them in the value of invested money.
The risk of not understanding the time value of money on the side of the investors is that they may end up making losses in their investments due to inflation that tends to affect the future value of a dollar in relation to its present value.
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Present Value Calculations
Calculating the present value the following must be provided;
Future value
Interest rate
Number of periods
The following is a step by step example of a present value calculation;
Suppose the future values of the project running for two years whose interest rate r = 10% are as follows; First year = $110,000 and second year = $121,000. Calculate the total present value of the project.
Step 1; Highlighting the Present Value Formula
The present value formula is, where
Step 2; Calculating Present value for each year
From the present value formula, increasing the interest rate with future value kept constant, the present value will decrease and vice versa. Increasing either the present value or future value while holding the interest rate constant will increase either of them depending on where the change occurred.
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Future Value Calculations
The following is a step by step example of a future value calculation;
Suppose a man made an investment of $5,000 to day with simple interest of 8%, how much will this amount worth in 10 years’ time?
Step 1; Highlighting the Present Value Formula
The present value formula is, where
Step 2; calculating the future value
From the formula, an increase in the principle amount and interest rate will increase the future value of the investment and vice-versa.
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Compounding Impacts on Present and Future Values Calculation
It impacts the Future Value of Dollars
There is an impact on Compounding Periods
There is an impact on Compounding Frequency
Compounding Impacts on Present and Future Values Calculation
Future Value of Dollars
It’s important to note that money tends to loss value over time, this implies that the future value of money is less than its current value. However, it must be noted that the compound interest can actually reverse the historical devaluation of every dollar. This indicates that an increase in inflation can drive the future value of money faster than time alone. Therefore the compound interest rarely compensates for the typical decline in the value of the dollar in the short term. But it can again counteract such a decline over longer periods.
Compounding Periods
The more the compounding periods, the stronger the impact on the future investment value.
Compounding Frequency
The higher the compounding frequency, the less the present value.
Example
If an investment is made, at the present with $5,000, its future value in 10 years will be much higher than that in 5 years. Similarly, its worth at a rate of 10% will be much higher than its value with 5% rate.
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Time Value of Money Concept Summery
Considerations
The number of periods
The yearly interest rate
The present value
In the time value of money concept, there are three main elements to be considered by the investors.
The number of periods that are involved in the investment; the more the investment period, the more the future value and the less the present value.
The yearly interest rate; the higher the interest rate, the less the present value and the higher the future value.
The present value; this determines what the future worth will be, therefore, the higher the present value, the higher the future value.
Importance of the Above Concepts
It’s important for the investor to understand these concepts since they determine whether the investment will make a loss or a profit. They also help in predicting what the anticipated value out of an investment is.
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