Last updated: March 23, 2019
Topic: FinanceAccounting
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Time value of money is a very practical concept which can be applied to any financial feasibility done over time. Since the value of money keeps changing due to inflation of currency, $1 today is usually equivalent to lesser that $1 after a year. This paper discusses the various applications of time value of money. (Cedar Spring, 2002)

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Applications

The best and most commonly cited example of application of time value of money is in investment. Take an example of a person wants to invest in a project that would get him 10% increase of value if the project goes well and 7% if the project doesn’t go well in the next five years. The project does not go well and the rate the investor got at the end of five years is only 7%. Since there was risk attached to he investment and the investor doesn’t get the maximum rate of return, the investor loses his/her money in comparison if he/she had invested somewhere else where there was a guarantee of an eight 8% return. (Kieso & Weygandt, 1993)

Time value of money can also be used to see the inflation and interest rate correlation. If a person decides to put $1000 in the bank today, that person would expect that $1000 to gain value in that one year to become $1100. However due to inflation, the purchasing power of that $1100 decreases and now that person can buy from $1100 what he could buy from $1000 a year ago. Thus in reality the amount invested in the bank hasn’t gained any real value. The bank’s interest rate only covers the inflation impact. (Kieso & Weygandt, 1993)

Another application of time value of money lies in the calculation of annuities. Annuities are a stream of fixed periodic payments over a specified time frame. Here a person who wants to invest for his child’s education of a total of $25,000 in 5 years, needs to invest more than $5000 each year to make the real value of the ending money bank to $25,000 due to inflation. (Kieso & Weygandt, 1993)

Another application of time value of money is the capital recovery problem or loan amortization payment problem. A person who needs to pay off the loan needs to pay off money each year including the interest charged per period. (Sherrick, Ellinger & Lins, 2000)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

References
Cedar Spring (2002). Time Value of Money. Get Objects. Retrieved March 24, 2009 from http://www.getobjects.com/Components/Finance/TVM/concepts.html

 

Kieso, D. and Weygandt, J. (1993). Intermediate Accounting, 9th Ed., New York: John Wiley & Sons, Inc.

 

Sherrick, B. J., Ellinger, P. N. and Lins, D.A. (2000). Time Value of Money and Investment Analysis.  Retrieved March 24, 2009 from http://agmarketing.extension.psu.edu/Business/FinancialTools/TimeValueMoneyP1.PDF