Chapter 5 Preview: Time Value of Money Concepts

Time value of money

The concept that money available today is worth more than the same amount in the future.

Present value (PV)

The amount of money a future amount is worth today.

Future value (FV)

The amount of money an investment will be worth at a future date.

Interest

The amount paid or received above the original amount borrowed or invested.

Interest rate

The percentage charged or earned on money.

Simple interest

Interest calculated only on the original principal.

Simple interest formula

Interest = Principal × Rate × Time.

Annuity

A series of equal payments made or received at equal intervals.

Ordinary annuity

An annuity with payments at the end of each period.

Annuity due

An annuity with payments at the beginning of each period.

Deferred annuity

An annuity where payments begin after the initial period.

Future value formula

FV = PV(1+r)^n.

Present value formula

PV = FV/(1+r)^n.

PV annuity

Used to determine the value today of a series of future equal payments.

FV annuity

Used to determine the future value of a series of equal payments.

Installment note

A promise to repay a loan through regular payments over time.

Common car/home loan repayment

Monthly installments.

Stated rate

The interest rate printed on a bond.

Coupon rate

Another name for the stated rate on a bond.

Market rate

The current interest rate for investments with similar characteristics.

Stated rate vs. market rate

The stated rate is printed on the bond; the market rate is the current rate for similar investments.

Pension funding

Companies generally contribute cash to pension funds during employees' employment.

Pension benefit factors

Future compensation levels and length of life.

Lease as an annuity

A lease is an annuity when it has equal payments at equal intervals.

Lessee lease measurement

The present value of the lease payments.

Capital leases and TVM

Capital leases require time value of money concepts.

Bonds payable and TVM

Bonds payable require time value of money concepts.

Pensions and TVM

Pension obligations require time value of money concepts.

Inventory and TVM

Inventory generally does not require time value of money concepts.

Monetary asset

An asset representing a fixed or determinable amount of money.

Examples of monetary assets

Cash, accounts receivable, and notes receivable.

Monetary liability

An obligation requiring payment of a fixed or determinable amount of cash.

Examples of monetary liabilities

Accounts payable, notes payable, and bonds payable.

Unknown variable: loan with known PV, rate, and periods

The payment amount.

Unknown variable: loan with known PV and payment

The number of periods.

Unknown variable: loan with known PV, payment, and periods

The interest rate.

George's $2,000 deposits

$20,053 because deposits are made at the beginning of each year, making it an annuity due.

Paul's $5,000 loan

9 years using the 8% present value annuity table factor.

Jean's $2,540 loan

5% implicit annual interest rate using the 6-period PV annuity factor.