(1) Ch 05 - Time Value of Money

always do your best. no matter the struggle, darling, always, always, do your best. do not let pessimistic mind get to you. You Will Strive.

What is Time Value of Money (TVM) ?

A concept.
Today’s money is worth more than the same amount in the future.

Why is today’s money worth more than (>) the same amount in the future?

Because you can:

• Invest it

• Earn interest

Or, you can:

• Buy a want/need

True or False:

Money sitting on a bank (not getting invested or anything) reduces its value.

True.
You can invest the money, earn interest, or you can buy a want/need.

The five terms we used to solve TVM problems are:

N = Number of periods

IR = Interest Rate ( % )

PV = Present Value

PMT = Payment

FV = Future Value

Interest Rate ( % )

The % of money you earn (or pay) on a certain amount of time

Based on interest rates,
if you save money, then the bank will give you:

The bank will give you extra interest (money)

Based on interest rates,

if you borrow money, then you will:

Then you will pay extra interest (money)

Future Value ( FV )

How much your present value will be worth in the future if you invest or earn interest on it.

Present Value ( PV )

Today’s money ^-^

Discounting =

The process of figuring out how much a future amount is worth today.

(iow: Finding the Present Value)

Compounding =

Your money earns interest on both the:

• original amount

• interest rate

True / False:

The more you compound your money, the more money you will end up with

True.

You will earn more money (with monthly compounding vs. semi-annual compounding)

What does Discounting help us determine?

Tells us the PV of a future cash flow.
Discounting helps us compare the two.

What does Compounding help us determine?

Determines how much our investments will grow over time.

(Iow: finding FV)

True / False:
Compounding shows how much your money now will be in the future?

True.

It helps show us the FV of a present cash flow.

Tough Question:
Why can’t you compare FVs without discounting them?

Because money has different values across time

Discounting brings all cash flows into today’s value

What’s the mistake in this statement:

“$1,000 today will be worth the same $1,000 in the future!”

It ignores the TVM concept.

You can do much more with today’s money than in the future.

Simple Interest

What’s the difference between Simple Interest and Compound Interest

• Simple Interest earns only on the original amount

• Compound Interest earns both the original amount and interest rate