Time value of money is an important concept of finance and financial management. It has been said that the present consumption reveals more value than a future consumption and it is because of the fact that consumers have two options; either to consume it right away or forego it to avail it in future by investing the present amount (Houston, and Brigham, 2009).
This report defines and highlights the importance of time value of money and also discusses the importance of time value of money for the financial managers. The report also calculates present value of money as well as the future value of money at different interest rates and duration. The report calculates the present and future value of annuities which are the annual stream payments. The report then discusses the main learning outcomes from this module.
Money losses its value with the passage of time particularly because different factors and inflation is the most important factor (Gitman, 2003). The value of $100 today is more than the value of $100 after 5 years because inflation would depreciate the value of $100 and fewer goods and services can be purchased from $100 after 5 years then today. In other words, it can be said that the value of $100 will have more buying power today than $100 after 5 years. So more things or value can be derived from $100 today than in 5 years from now. Thus, it shows that the money changes its value with the passage of time and as time passes, the value of money decreases and this concept is defined as time value of money (Besley, & Brigham, 2007).
Importance of time value of money to financial managers
Time value of money is an important concept in business as well. It is significant for financial managers need to understand the concept of time value of money because it influences the returns that the company would be making in the years to come. The financial managers not only need to understand the present value of future cash flows, but also the future values of a present investment they are making. Thus, they need to understand the concept of discounting (calculating the present value) as well as compounding (calculating the future value).
There are different reasons why the financial managers need to understand and use the concept of time value of money and one of the main reasons is while making the investment decisions. The concept of time value of money has been used very frequently by investors and financial managers. The reason to use the concept of time value of money while making investment decisions is to analyze the worth of the investment. If the project is not going to yield sufficient returns or the present value of the future returns are not more than the present value of the investment then there is no point of making the investment. This concept is generally termed as Net Present Value of the investment (NPV) and it is used on a regular basis to analyze the worth of the project or investment decisions. Therefore, this is one of the reasons why investors and financial managers should understand the concept of time value of money (Gitman, 2003).
Another important reason why the financial managers need to know and understand the concept of time value of money is that while raising funds they need to know the cost they would be paying to the bank or the financial institution or bond holders etc and by knowing the cost of the funds and the future value that would be paid to them, financial managers would be able to identify the present value of the future cash flows and then make an appropriate decision (McLaney, 2009).
Calculating future values
Formula to calculate the future values
a. $150,537.19 if invested for seven years at a 5% interest rate
b. $237,891.22 if invested for eight years at a 3% interest rate
c. $320,891.12 if invested for ten years at an 11% interest rate
d. $520,520.22 if invested for thirteen years with a 13% interest rate
Calculating present values
Formula to calculate the present values
a. $562,126.17 to be received seven years from now with a 5% interest rate
b. $225,003.21 to be received six years from now with a 6% interest rate
c. $321,567.35 to received five years from now with an 18% interest rate
d. $63,000.05 to be received twelve years from now with a 5% interest rate
present value of AN ANNUITY
Formula to calculate the present value of an annuity
FUTURE Value of an annuity
Formula to calculate future value of an annuity
Learning from Module 2 Case Assignment
Module 2 case assignment has been helpful in making me learning a lot of things. The module 2 has helped me in knowing the value of money at the present time and also I have learnt that the value of money tends to decrease as the time goes on. The module has helped me in learning about the concepts that different factors such as inflation can influence the value of the money and thus the purchasing power or the buying power of the consumers decrease if the money is not spent today. Therefore, there are two options for the consumers; either they can invest the money to increase its value. For instance, investing the money in a bank would yield 5% annually and this would increase the money, though, not the value of money. So the consumer can have similar buying power in next year when he or she plans to spend. Not only this, I have calculated present and future values and thus, it can be said that this module has helped me in making basic calculations related to the present value and future value of money.
Similarly, the module has been helpful in making me learn about the impact of the interest rate and the impact of the life of the investment can influence the value of the money. The module asked to identify the present value as well as the future value at different interest rates and at different durations of investment and thus, it helped me in analyzing and identifying the impact that these two factors make on the present value or the future value of the investment. So, I not only have learnt how to calculate the present value and future value, but I have also learnt and have understood these concepts, their implications and practical applications.
In addition to this, the module has helped me in knowing how financial managers and business owners need to understand the concept of time value of money and how to use it in an efficient manner. There are different decisions that financial managers need to make and these decisions can be influenced because of the time value of money, so it is important for them to understand and use this concept.
Time value is an important concept in financial management and this report highlighted and discussed the importance of time value of money as well as the significance of understanding the concept of time value for the financial managers. The report identified the main reasons why the financial managers need to understand and learn these concepts. Moreover, I have also calculated the present and future value of cash flows along with calculating present and future values of annuities in this module. The last section of the report discusses about the main learning that I have learnt from this module.
Besley, S., & Brigham, E. (2007). Essentials of Managerial Finance, 14 edn. USA, Thomson Higher Education.
Gitman, L. (2003). Principles of Managerial Finance. Boston, Addison-Wesley Publishing.
Houston, F., and Brigham, F. (2009). Fundamentals of Financial Management. Ohio, South-Western College Pub.
McLaney, E. (2009). Business Finance: Theory and Practice. Pearson Education: New Jersey.