Week 1 Individual Paper
Time Value of Money Paper
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 ...view middle of the document...
Future Value is the amount of money that an investment made today (the present value) will grow to by some future date. Since money has time value, we naturally expect the uture value to be greater than the present value. The difference between the two depends on the number of compounding periods involved and the going interest rate.
Opportunity 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.
An annuity is a series of equal payments or deposits made over equal time periods. Every household has a form of annuity that needs to be paid weekly, monthly, or yearly. For example, when a bank loans money to a business, their terms are to be paid back in return at a set fee monthly or quarterly. That fee or rate is set by the interest rate so future values are covered and there is a profit for the bank.
The Rule of 72 is a formula used to compute the length of time it will take for money that was invested to double at the given compound interest rate, which is 72 divided by the interest rate. For...