Chapter 3 Time Value of Money

Chapter 3

• The Time Value of Money

After studying Chapter 3, you should be able to:

• Understand what is meant by "the time value of money."
• Understand the relationship between present and future value.
• Describe how the interest rate can be used to adjust the value of cash flows – both forward and backward – to a single point in time.
• Calculate both the future and present value of: (a) an amount invested today; (b) a stream of equal cash flows (an annuity); and (c) a stream of mixed cash flows.
• Distinguish between an “ordinary annuity” and an “annuity due.”
• Use interest factor tables and understand how they provide a shortcut to calculating present and future values.
• Use interest factor tables to find an unknown interest rate or growth rate when the number of time periods and future and present values are known.
• Build an “amortization schedule” for an installment-style loan.

The Time Value of Money

• The Interest Rate
• Simple Interest
• Compound Interest
• Amortizing a Loan
• Compounding More Than Once per Year

The Interest Rate

• Obviously, $10,000 today.
• You already recognize that there is TIME VALUE TO MONEY!!

• Which would you prefer – $10,000 today or $10,000 in 5 years?

Why TIME?

• TIME allows you the opportunity to postpone consumption and earn INTEREST.

• Why is TIME such an important element in your decision?

Types of Interest

• Compound Interest
• Interest paid (earned) on any previous interest earned, as well as on the principal borrowed (lent).

• Simple Interest
• Interest paid (earned) on only the original amount, or principal, borrowed (lent).