Time Value Of Money
A very important concept in financial management is known as the time value of money. Abbreviated as TVM, it distinguishes various alternatives in investment in order to solve problems related to loans, mortgages, savings or annuities. Lets tour some frequently asked questions pertaining to TVM as listed below.
1.What is TVM? TVM works on the principle that a dollar that you earn today is worth more than that of a dollar you receive in the future. This way, you tend to invest that money and earn from that money now only. According to the TVM concept, the amount of money either as a lump sum amount or in the form of equally distributed payments that are to be received in future, can be converted in to same amount of money today and vice versa. 2. How does money have time value? Money has time value. The longer we wait to receive the present value of money that is to be received in future, the lesser it becomes. Present value is that amount of money which is equivalent to some future amount of money, discounted by an appropriate rate of interest. This future money can be received as a lump sum amount or in terms of equally distributed payments, at the end of a period. Present value may comprise a single amount or it may be an annuity. 3. An annuity is a series of payments received at equal intervals. How does it connect with present value? Present value of an annuity can further be classified as follows: Present Value of Ordinary Annuity Present Value of Annuity Due In an ordinary annuity, the payments are received at the end of each period while in case of annuity due, the payments are received at the beginning of each period. Present Value of an Annuity Due, known as PVad is almost similar to an ordinary annuity except that here the payments are received in the beginning of each period. That means one period earlier. Thus, the Present Value can be calculated as the present value of an ordinary annuity, multiplied by 1 plus discounted rate of interest each period. Consider the following: PVad = Pvoa(1+i) where PVad = Present Value of an Annuity Due Pvoa = Present Value of Ordinary Annuity i = Discounted Rate of Interest per Period 4.How are payments calculated? The payments are calculated as per the abovementioned formula. The formula can either be cash inflows or cash outflows. In case of cash inflows, the present value is assumed to be an outflow and if the payments over time turn out to be outflows then the present value is assumed to be an inflow. In conclusion, it can be rightly stated that the present value interest factors for annuities due are a great help to calculate the present value of an annuity due. These interest rate factors for annuity due problems are computed from the ordinary PVIFA values. There is no need to use separate notations and sets of annuity rate of interest's tables. Time Value of Money (TVM) is an important concept in financial management. With an understanding of this, you can understand investment alternatives in a better and more efficient way. |
