Time Value Money (TMV)

The concept of annuities is that a constant amount of money is deposited for investment (compounding ) after every fixed interval . The interest rate is fixed . The intervals are equally spaced out . The final sum will be calculated using the annuity formula

[Ross E (2006 )]

Present Value and Future Value are explained later . C ' stands for the cash flow amount . This is the amount deposited /invested regularly at the interest rate r ' for t ' number of time periods

Investing compounds the interest and results in a sum of money greater than

simple compounding . Annuity compounding is a way in which payments made over time are allotted to the compounding effect . The formula above are easy to use and provide a summary quickly as to the Future , Present Values of money

1 ) Interest Rates and Compounding

The Interest rate is the main factor why time value of money concept is there . If the interest rate is zero , the value of money will never decrease . Compounding is the opposite of simple interest . Every year when the interest is added to the original amount , it is also added to the principal for the next year 's investment . Example : You invest 1000 for 10 years at 19 annually . At the end of Year 1 , you have 100 interest . The interest is not put into a separate account . It is added to the 1000 . So for Year 2 , the interest is calculated on the investment of 1100 (which is 1000 original 100 interest . This concept of compounding results in huge differences between simple interest and compound interest . This is the basis for the annuity calculations

[Ross E (2006 )]

2 ) Present Value (of a future payment received

The concept of Present Value of money is simple to explain . We know that if we have some amount of money today and we are able to purchase 10 cakes for it , the next year , we will not be able to buy the same 10 cakes . This is because the money value ' will decrease . So , there is a fall in value of money with time . In rare cases (Japan , 2007-2008 there was an opposite case with a very small difference . So , this decrease in money value ' can be found using the formula

[Block , Hirt (2005 )]

PV FV (1 r )t

PV : Present Value

FV : Future Value

R : Interest Rate

T : Time Period of the Investment

There are four parts to this equation

PV , FV , r and t

If we know any three , we can solve for the fourth

Present Value and Future value are values ' for the same amount ' of money . Example : The value of 1000 today will be 900 after 1 year if the interest rate is 10 . However , this does not mean that you will have actual 900 in your hand . You will have the same 1000 , but you can buy only 900 amount of goods with that money . This shows that money value has decreased with time flow

[Block , Hirt (2005 )]

We calculate...