Essay on Time Value Of Money

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Time Value of Money

Time Value of Money To make itself as valuable as possible to stock holders; an enterprise must choose the best combination of decisions on investment, financing and dividends. In any economy in which firms have the time preference, the time value of money is an important concept. Stockholders will pay more for an investment that promises returns over years 1 to 5 than they will pay for an investment that promises identical returns for years 6 through 10. Essentially one must determine if future benefits are sufficiently large to justify current outlays. The development of mathematical tools of the time value of money is important as the first step towards making capital allocating decisions (Malawi, 2008).
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Compounding is the arithmetic process of determining the final value of a cash flow or series of cash flows when compound interest is applied (Malawi, 2008).
The following are the variables used in the mathematical modeling of time value of money:
FV = Future value
PV = Present value
A = Annuity Value i = Interest rate n = Number of periods
As an example, what is better, investing a $100 per month or investing $1200 once a year for the next 20 years at an interest rate of 5%? Using the future value of annuity relationship, FVa = A *[ ], one finds that saving on a monthly basis gains us ($41,009-$39,679) $1,330.0 after 20 years.
Table 1, Example of annuity earnings for $1,000.0 (Block & Hirt, ch9 p242)

Even better would be to invest the whole amount up front as "an asset with interest compounded annually: = Original Investment x (1+interest rate)^number of years" (Investopedia ULC, 2008) and let it set for 20 years as demonstrated in table 2. Where:
FV = PV (1 + i)n i = interest rate = 5% = 0.05 n = number of years = number of periods = 20.
PV = $24,000
Table 2, $24,000 compounded over a 20 year period.
First Year $24000.00 x 1.05 = $25200.00
Second Year $25200.00 x 1.05 = $26460.00
Third Year $26460.00 x

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