Time Value of Money
1) How would you define time value of money in your own words? Please provide a brief definition of time value of money in your own words.
The concept of time value of money refers to the value of the current amount of money figured to a future approximate interest value of money earned after a given time interval. Most people fail to understand the concept of time value of money because of the calculations involved. However, the concept of time value of money ought to be understood by almost all the people in the world since it involves the interest accumulated on money over a period. To understand the concept of time value of money I would use a simple illustration that would trigger the concept into a more understanding nature (Brealey, Myers & Allen, 2005).
For instance, if one was informed to have worn a jackpot or any given prize of $10, 000 after a certain competition, and asked if he/she was given two options regarding the delivery of the money. Option A concerns that the individual who is the winner is supposed to receive the given amount immediately and option B is to earn the same amount after a period of three years in the future. Which is the most profitable and likely option that the individual is suppose to select in regardless to the profitable amount in relation to the money earned (Drake & Fabozzi, 2009).
In accordance to the given illustration, offering the 10, 000 dollars to the winner at the current moment is the most probable option that almost all the people will prefer compared to the other available options. The benefit of receiving the payment now is the fact that the money will poise to earn an interest from the various investment readily available (Brealey, Myers & Allen, 2005). However, for the other option, B, there is no time on the side of the prizewinner. Since the payment will be offered in duration of three years, he/she cannot invest the money and earn the same interest as given in option A. The given illustration can be represented as indicated
Figure 1 A representation of the concept of Time Value of Money
In according to the illustration in the figure above, it is vivid that the individual choosing option A, the future value of the present capital will be and the current value, 10,000 dollars plus the interest earned with the money over a period. However, for the option B, after the three years, the individual will only earn 10,000 dollars without any given interest.
2) To what extent is it important for financial managers to understand the concept of time value?
It is extremely important for the financial managers to understand the concept of time value because of the fact that managers ought to earn the interest of the money earned. Financial managers ought to control the amount of interest earned. In most financial firms, managers ought to understand the concept of time value to understand the profitable gain (Lieuallen, 2008). Most of the firms rely on the profitable interests to increase the investments of the firm. In most cases, financial managers will embark on the time value of money to make the appropriate earnings that are vital in the sustaining the continuity of the firm.
Financial managers also are concerned with the control of the amount of salaries that the other members of the organizations receive. In understanding the concept of time value of money, it is easier for the financial managers to denote the exact amount of payment that the employees will receive (Brealey, Myers & Allen, 2005). In certain companies, the employees are paid the salary after a given period in relation to the amount of work done. In certain financial firms, the financial manger is also responsible for making the budget of the firm. The budget is important in the realization of the manner in which the firm will use the available funds (Megginson & Smart, 2009).
3) Calculate the future value of the followings:
a. $204,298 if invested for five years at a 7% interest rate
Present value (PV) (1+k)t = Future Value
=$204,298 (1+0.07)5
Future value = 204298*1.075
Future Value = $286538.5135
b. $319,112 if invested for three years at a 4% interest rate
Present value (PV) (1+k)t = Future Value
=$319,112 (1+0.04)3
Future Value = $319,112 (1.04)3
Future Value = $358957.601
c. $311,124 if invested for seven years at an 2% interest rate
Present value (PV) (1+k)t = Future Value
=$311,124 (1+0.02)7
Future Value = $311,124 (1.02)7
Future Value = 357383.680
d. $299,129 if invested for ten years with a 0.9% interest rate
Present value (PV) (1+k)t = Future Value
=$299,129 (1+0.009)10
=$299,129 (1.009)10
Future Value = 327167.520
4) Calculate the present value of the followings:
a. $652,126 to be received three years from now with a 4% Interest rate
Present Value = (FV) 1/ (1+k)t
= $652,126*1/ (1+0.04)3
Present Value = $652,126* 0.888996
= 579739.7009
b. $128,231 to be received five years from now with a 5% interest rate
Present Value = (FV) 1/ (1+k)t
=$128,231*1/ (1+0.05)5
Present Value =128,231* 0.783526
=100472.3438
c. $591,199 to received two years from now with a 12% interest rate
Present Value = (FV) 1/ (1+k)t
=$591,199*1/ (1+0.12)2
=$591,199* 0.7972
=471300.22
d. $187,111 to be received eight years from now with a 1% interest rate.
Present Value = (FV) 1/ (1+k)t
=$187,111*1/ (1+0.01)8
=$187,111*0.9235
= 172793.8692
5) Suppose you are to receive a stream of annual payments (also called an “annuity”) of $193,723 every year for three years starting this year. The interest rate is 4%. What is the present value of these three payments?
Present value interest factor of annuity (PVIFA) = 2.7751
Present value = PVIFA* annuity
Present value = 2.7751* $193,723
= 537600.6973
6) Suppose you are to receive a payment of $292,595 every year for three years. You are depositing these payments in a bank account that pays 2% interest. Given these three payments and this interest rate, how much will be in your bank account in three years?
Future Value of Annuity = Annuity {(1+k)t-1/k}
=$292,595 {1.0612-1/0.02}
=$292,595 (0.612/0.02)
=$292,595* 3.0604
=895457.738
7) What do you perceive you have learnt in Module 2 Case Assignment? Which of the following learning objectives do you feel you have mastered?
In relation to the module 2 case assignment, I have gained both the concept in which the present and the future time value of money is calculated. This is achieved through the various calculations that I have undertaken in the assignment offered. In conducting the assignment, I have also learned the concepts and discussions concerning the present and the future value (Lieuallen, 2008). In relation to the module 2 case assignment, it is vivid that the assignment is important in calculating the values of the present and the future amounts of interest earned.
References
Brealey, R.A., Myers, S.C., & Allen, F. (2005).Principles of corporate finance, 8th Edition.The McGrawâHill.
Drake, P. P., & Fabozzi, F. J. (2009). Foundations and applications of the time value of money. Hoboken, N.J: John Wiley & Sons.
Lieuallen, G. G. (2008). Basic federal income tax. New York: Aspen.
Megginson, W. L., & Smart, S. B. (2009). Introduction to corporate finance. Mason, Ohio: South-Western Cengage Learning.
