The principles of time value of money and learning its techniques are the most important concepts for the study and application of finance in general. The concept of interest is divided between simple and compound interest. Simple interest is calculated only by taking into consideration the beginning principal. For instance, if an individual invested $1,000 dollars in a savings account at 5% annual interest, the expected return after one year would amount to a $50 gain on investment. The concept of compound interest unlike simple interest which only takes into consideration the interest return of the initial principal investment is determined by taking into consideration not only total interest on the principal, but it also includes any interest gained on the initial investment. In simple terms, compound interest calculations encompass interest on interest. It is of paramount importance for a finance manager to understand and have a through understanding of time value of money concepts and its impact on the value of an asset at a specific point of time in order to be successful. Present and Future Value of an Investment For a company one of the most important tools in determination in the time value of money analysis for a specific asset is the cash flows time line. The cash flows time line indicates and helps us visualize when the cash flows related to a particular transaction occur in respect to when the transaction originated. Constructing a cash flow time line will help determine how the timing of cash inputs and outputs will affect the day to day operations of the firm. By utilizing the cash flows time line a person can determine the potential future value of an investment today and how the process of compounding interest on the initial investment affects the total value of the initial investment and its aggregate return on the simple interest. In order to calculate the effect of compound interest in an investment a person needs to use the compound interest formula (Studyfinance). TV = P1 (1+I)^n TV= total value investment value at the end of n periods P1= initial investment I= interest N= number of periods or years Finance textbooks provide the user with future and present compound interest tables. These tables are calculated in order to simplify the process and provide a guideline to the user with help in determining present and future value of any investment. The tables provided are calculated by determining the value of an initial investment for various time periods and interest rates. The opportunity value of an investment is the rate of return on the best investment alternative taking into consideration the available options of equal risk. On the other side of the coin, the compounded present value of an initial investment is calculated by determining the reciprocal amount of compound interest for the same future period (Studyfinance). Another way of visualizing present value of an investment is to adopt a stance where the initial investment value is determined by the interest rate and time period of the future investment window. For investors present value calculations determine where individuals invest their limited funds taking into consideration their actual financial performance and risks and overall return. For potential investors present
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Overview Although time value of money is not something that we normally think about, it is a concept that is used in our everyday lives, from banking and business, to investing and saving. The concept of interest lies at the root of the time value of money…
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