Time Value of Money

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Abstract The first steps toward understanding the relationship between the value of dollars today and that of dollars in the future is by looking at how funds invested will grow over time. This understanding will allow one to answer such questions as; how much should be invested today to produce a specified future sum of money? Time Value of Money In most cases, borrowing money is not free, unless it is a fiver for lunch from a friend. Interest is the cost of borrowing money. An interest rate is the cost stated as a percent of the amount borrowed per a period of time, usually one year. The current market rates are composed of three items. The Real Rate of Interest is what compensates lenders for postponing their own spending…show more content…
Opportunity cost is a basic term from the disciplines of economics and accounting. The acceptable definition of the term is, "The advantage forgone as the result of the acceptance of an alternative." For example, the opportunity cost of a single glass of beer is about $7.00. The generally accepted Opportunity Cost factor, including inflation, is 6.7. Therefore, that $1.00 glass of beer cost the buyer about $7.00 in future earnings. Opportunity cost is an important concept in financial decision-making. There is a useful rule of thumb for incorporating opportunity cost into financial decision-making. If faced with a spend-or-invest trade-off and deciding to pay off debt, subtract the projected income earned on the investment to calculate a net savings. If deciding to invest, subtract the projected interest paid off on the debt to calculate net savings. The Rule of 72 is a simple financial rule that simply states that investments will double its initial amount every 72 periods that it is compounded. The formula is written like this: 72/r where: r = the rate of return per period. In other words, an initial amount such as $1000 which has a fixed rate of return of 20% will double itself in just over three and a half years, 72/20 = 3.6. This kind of financial equation is very handy to use when you need to compare investment opportunities or loans such as home loans. The Rule of 72 is commonly used in all areas of personal finance and financial planning,

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