Chapter 5 Time Value of Money Concepts

Key vocabulary and concepts related to the time value of money, including types of interest, annuities, and accounting applications.

Time Value of Money

The concept that money can be invested today to earn interest and grow to a larger dollar amount in the future.

Interest

The amount of money paid or received in excess of the amount of money borrowed or lent.

Simple Interest

Interest calculated as the $\text{Initial investment} \times \text{Annual Interest rate} \times \text{Period of time}$.

Compound Interest

Interest that includes return not only on the initial investment but also on the accumulated interest earned in previous periods.

Effective Rate

The annual rate at which money actually grows during a year, reflecting the effects of compounding frequency.

Future Value (FV) of a Single Amount

The amount of money that a dollar will grow to at some point in the future, determined by $\text{FV} = \text{I} \times \text{FV Factor}$.

Present Value (PV) of a Single Amount

Today’s equivalent to a particular amount in the future.

Monetary Assets

Money and claims to receive money in the future, the amount of which is fixed or determinable, such as cash and most receivables.

Monetary Liabilities

Obligations to pay amounts of cash in the future, the amount of which is fixed or determinable, such as notes payable.

Annuity

A series of cash flows of the same amount received or paid each period.

Ordinary Annuity

A series of constant cash flows where payments occur at the end of each period.

Annuity Due

A series of constant cash flows where payments occur at the beginning of each period.

Deferred Annuity

An annuity that exists when the first cash flow occurs more than one period after the date the agreement begins.

rate (Excel Input)

In the Excel FV or PV functions, this represents the interest rate per period.

nper (Excel Input)

In the Excel FV or PV functions, this represents the total number of periods.

pmt (Excel Input)

In the Excel FV or PV functions, this represents the payment amount each period; it is entered as $0$ for a single amount.

pv (Excel Input)

The present value, or the lump-sum amount today, used in Excel functions (entered as $0$ for annuities).

type (Excel Input)

A number ($0$ or $1$) in Excel indicating whether annuity payments are made at the end ($0$) or beginning ($1$) of each period.