Finance 254
Time Value of Money (Annual Periods)
Time value of money is just another way of saying that we would rather receive a payment of $X today
than tomorrow.
If we have money today but do not want to spend it until a later date, we can always
place the money in the bank and earn interest on the balance, which is the “opportunity cost”
explanation for the time value of money.
In addition to the “opportunity cost,” there is an element of
uncertainty involved with any cash flow that is to occur in the future.
There is always a positive
probability that the borrower will not repay the loan, which leads to an important component of interest
rates.
The Variables
Time value problems have five general variables which we should define before we go any further:
Present Value (PV):
This is the value today (t = 0), and is sometimes referred to as the Market Price.
Future Value (FV):
This is the single terminal cash flow at a specified future date.
Interest Rate (i):
The rate of return earned on investments of an assumed level of risk.
Number of Time Periods (N):
The number of time periods considered in a problem.
Payment (PMT):
The size of regularly occurring annuity payments.
Single Cash Flows:
Time Lines and Equations.
To understand the time value of money, timelines are the best place to start.
Always start a time line by drawing the line itself and anchoring it at t=0 and t=N which are the dates of
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 Fall '09
 FIN221
 Time Value Of Money, Net Present Value, Pmt Pmt Pmt

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