Time Value of Money Acct 291 Appendix GIntroduction • In business money has a different value today than it has in the future • $2000 received today is more valuable than $2000 received in 5 years • Businesses use the concept to figure out how much to charge for things if the customer is going to We also discuss several other topics like utoledo blackboard
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pay over time • Businesses use the concept to determine how much to pay for something depending on the terms of payment • The alternative use for cash received or paid today is investing it at some interest rate for a period of time • Time value of money is a basic calculation that requires knowing • The future value or the present value • An interest rate • A time periodWhat do you need to know? You will need to • Know the definitions of terms associated with time value of money • Calculate present values and future values of both single amounts and annuities • Recognize the correct interest rate to use when calculating present values and future values • Determine the correct time periods to use when calculating present values and future values • Recognize when a cash flow is a future value and when a cash flow is a present value • Use the facts in a scenario to solve time value of money problemsTerms • Principal • The amount borrowed • Interest • The payment for the use of another person’s money • = Amount of cash repaid – principal • Future value • The value of some amount of money invested at a particular interest rate at a future date • Present value • The value today of some amount of money received or paid at a date in the future given a particular interest rate • Annuity • A series of payments of equal amounts at regular intervalsCalculating future value of a single sum • If the cash flow amount is today and you are trying to find what it is worth at some date in the future • Use Future Value of $1 table on page G-4 to find the factor to use in the calculation Present value * factor = future value • Next you need to calculate the right n and i to find the right factor • n is the number of periods = years in the future * number of compounding periods per year • i is the rate per period = annual interest rate/number of compounding periods per year• Assume that you need to calculate either a present or future value. Which interest rate column and number of periods do you use when working with the following rates and years? 8% compounded quarterly for 4 years i = ______% n = ______ 12% compounded annually for 5 years i = ______% n = ______ 6% compounded semiannually for 3 years i = ______% n = ______ 12% compounded monthly for 2 year i = ______% n = ____• Liam Company signed a lease for an office building for a period of 12 years. Under the lease agreement, a security deposit of $9600 is made. The deposit will be returned at the expiration of the lease with interest compounded at 4% per year. What amount will Liam receive at the time the lease expires?Calculating the present value of a single sum • Find the value today of an amount to be received in the future • Future value * factor = present value • Find the factor in Table 3 on page G8• Messi Company is considering an investment that will return a lump sum of $900,000 6 years from now. What amount should Messi Company pay for this investment to earn 8% return?What if instead of a one time amount, cash flow is an annuity? • Very common cash flow • Equally spaced payments of equal amounts • House payments • Car payments • Retirement investment • Use Table 2 on page G-6 for future value • Use Table 4 for present value