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In order to make sound financial decisions as a manager, investor, or customer it is critical to comprehend time value of money. Since businesses and individuals finance a large portion of their main resources knowing how the system works helps to make informed choices regarding financing options. To best evaluate financing or investment opportunities one must understand time value of money concepts such as interest rates, compounding, present and future values, opportunity cost, annuities, and the Rule of '72. These concepts help one interpret the value of money today versus the value of money in the future as well as borrowing costs.Interest rates and compoundingInterest is defined as the ...view middle of the document...

Future ValueFuture value is the opposite of current value. The future value of money is assumed to be greater than the current value. The longer the money is left to earn interest the more profit generated. Future Value is the amount of money that an investment made today (the present value) has the potential to become greater in amount in the future. Since money is time valued, and if invested properly one can expect the future value to be greater than the present value. The difference between the two depends on the number of compounding periods involved, the rate of inflation, and current interest rates.Opportunity CostOpportunity cost is a basic concept in economics. The opportunity cost refers to what must be given up or the second best alternative when a particular decision is made. It suggests that there is a cost or risk involved in decision making. To illustrate this point lets say an investor decides to invest $500 in stock A. At the end of the quarter the investor may discover that investing in stock A was profitable, however investing in stock B would have produced a greater return. Therefore, by investing in stock A instead of stock B was the opportunity cost.Rule of 72"The Rule of 72 states that the time it will take for an investment to double in value equals approximately 72/r, where r is expressed as a percentage" (Brealey, Myers, & Marcus, 2004, p. 78). To...

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