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 well as borrowing costs.
Interest is defined as the "rent" paid to borrow money ("Interest," 2007, para. 1). Compound interest refers to interest that is applied to the original loan amount and later interest added on to the original borrowed total plus the added interest ("Compound interest," 2007). Therefore if one was to borrow X amount of money for payback over a two year period, the repayment amount would be calculated by adding the original borrowed figure to the interest rate plus compound interest where applicable. Obviously, increasing interest and allowing for longer repayment terms is highly beneficial to the lender.
The present value of a future payment is how money can be related to what we think that it will be worth in the future. In order to determine the worth it is based of expected future earnings. An example would be when there is a 5% return, $500 is the present value of the $525 that is expected to be gained in a year from investing. By using the present value of future payment you can strongly assume what you will need to have in a certain period of time. When putting money away for vacation, you know that you will need $3000 for the trip. If you had 2 years to pay for the vacation, you could put $3000 into a bank at 5% interest rate and you could...