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PK05 - Chapter 5 The Time Value of Money Learning...

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Chapter 5 The Time Value of Money Learning Objectives 1. Explain what the time value of money is and why it is so important in the field of finance. 2. Explain the concept of future value, including the meaning of principal amount, simple interest, and compound interest, and be able to use the future value formula to make business decisions. 3. Explain the concept of present value and how it relates to future value, and be able use the present value formula to make business decisions. 4. Discuss why the concept of compounding is not restricted to money, and be able to use the future value formula to calculate growth rates. I. Chapter Outline 5.1 The Time Value of Money A basic problem faced by managers in financial decision making is to determine the value of a series of future cash flows, whether paying for an asset or evaluating a project. The question that is being raised is: What is the value of the stream of future cash flows today? We refer to this value as the time value of money . 1
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A. Consuming Today or Tomorrow People prefer to consume goods today rather than wait to consume similar goods in the future—that is, a positive time preference. The time value of money is based on the belief that people have a positive time preference for consumption. Money has a time value because a dollar in hand today is worth more than a dollar to be received in the future. The dollar in hand could be either invested to earn interest or spent today.
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