Chapter 5. TVM impact on investments
The time value of money concept is used to compare investment alternatives and to solve problems involving loans, mortgages, leases, savings, and annuities.
How to
You should already know from the previous chapters that TVM is based on the concept that a dollar that you have today is worth more than the promise or expectation that you will receive a dollar in the future (because you can invest your dollar today and earn compounded interest). Your money grows with time. For example: if you invest one dollar at 6% annual interest, you are sure to collect a future value of $1.06 by the end of your investment. Consequently, it is safe to say that in order to receive $1.06 in the future, you need to invest $1.00 as present value.
The correlation between the present and future value can be calculated to determine the value of a single sum of money or a series of equal, evenly-spaced payments promised in the future. It can be converted to an equivalent value today (present value) and a single sum or a series of payments will grow to at a future date (future value). This chapter is not intended to teach you the formulas you need to do the calculations. Today's technology provides an ample number of applications to help with such mathematical equations. Our intention here is to help you reason logically so you can recognize a correct answer from an incorrect one, or, as accurately as possible, estimate a present or a future value.
In any investment scenario, you can calculate an unknown value if you have any four of the following:
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- Interest rate (simple or compounded)
- Number of periods (years, months, and/or days)
- Payment amount (inflow or outflow)
- Present value (single amount or annuity)
- Future value (single amount or annuity)
Regardless of what you are trying to find out, understanding the time value of money can seriously positively impact the way you make financial decisions.
Practice
Now that you know the logic behind the time value of money concepts, think of paying it forward and discuss your findings with a friend or a family member.
Congratulations! Now Test your knowledge about Time value of money!
Would you like to review again? You can start over at Introduction.
To review the full module on Time value of money, click here.
The Penn State Sokolov-Miller Family Financial and Life Skills Center hopes you have enjoyed this module in the MoneyCounts: A Penn State Financial Literacy Series. Please tell us how we can serve you better, leave us a feedback, ask a question, or request additional information at: finlit@psu.edu