Accounting Valuation Models
Time value of money
a)
What is meant by the time value of money?
Money received sooner rather than later allows one to use the funds for investment or
consumption purposes.
b)
If I invest $1,000 today, what amount will I have at the end of one year if the
interest rate is 10% compounded annually?
Interest = 1,000 x 10% =100
Total =1,000+100= 1,100
Alternative calculation 1,000 x 1.10 =1,100
c)
If I invest $1,000 today, what amount will I have at the end of 3 years if the
interest rate is 10% compounded annually?
Year 1
Interest = 1,000 x 10% =100
Total =1,000+100 = 1,100
Year 2
Interest = 1,100 x 10% =110
Total =1,100+110 =1,210
Year 3
Interest = 1,210 x 10% =121
Total =1,210+121= 1,331
Alternative calculation =1,000 x 1.10 x 1.10 x 1.10 =1,331
In these two examples, the investment 1,000 is the “Present Value” and the 1,100 is the
“Future Value at the end of year 1” and the 1,331 is the “Future Value at the end of year 3”
They are all equivalent in value.