Access over 20 million homework & study documents

Effective rate of inrest in time_value_of_money

Content type
User Generated
Type
Study Guide
Rating
Showing Page:
1/10
Time Value of Money
Time Value of Money is an important concept in financial management. It is one of the
important tools used in project appraisals to compare various investment alternatives, and
solve problems involved in loans, mortgages, leases, savings, and annuities.
A key concept behind Time Value of Money is that a single sum of money or a series of
equal, evenly spaced payments or receipts promised in the future, can be converted to an
equivalent value today. Conversely, you can determine the value to which a single sum or
a series of future payments will grow to at some future date. The former is called Present
Value of Cash Flows and the later is called Future Value of Cash Flows.
Session 4: Time Value of Money
Learning Objective
Explain to the learner on the concept of time value of money.
Important Terms
Time line
Discounting
Compounding
Principal amount
Simple interest
Annuity
Amortized loan
Time Value of Money
To make itself a valuable as possible to stock holders; an enterprise
must choose the best combination of decisions on investment,
financing and dividends. In any economy in which individuals, firm and
governments have the time preference, the time value of money is an
important concept. Stockholders will pay more for an investment that
promises returns over years 1 to 5 than they will pay for an
investment that promises identical returns for 6 years through 10.
The decision to purchase new plant and equipment or to introduce a
new product in the market requires using capital allocating or capital
budgeting techniques. Essentially we must determine whether future
benefits are sufficiently large to justify current outlays. It is important
that we develop the mathematical tools of the time value of money as
the first step towards making capital allocating decisions.

Sign up to view the full document!

lock_open Sign Up
Showing Page:
2/10
Principal amount (P)
This is the amount of money that is initially being considered. It might
be an amount to be invested or loaned or it may refer to the initial
value or cost of plant or machinery. Thus if the company was
considering a bank loan of say K500,000, this would be referred to as
the principal amount borrowed.
Accrued amount (A)
This term is applied generally to a principal amount after some time
has elapsed for which interest has been calculated and added.
Simple and Compound Interest
When an amount of money is invested over a number of years, the
interest earned can be dealt with in two ways.
SIMPLE INTEREST
This is where any interest earned is NOT added back to the principal
amount invested.
For example, suppose that K200,000 is invested at 20% simple
interest per annum. The following table shows the state of the
investment, year by year:
Year
Principal
Interest earned amount
Cumulative amount
1
200,000
40,000 (20% of 200,000)
240,000
2
200,000
40,000 (20% of 200,000)
280,000
3
200,000
40,000 (20% of 200,000)
320,000
… etc.
COMPOUND INTEREST
The notion of compound interest is central to understanding the
mathematics of finance. The term itself merely implies that interest
paid on loan or an investment is added to the principle. As a result,
interest is earned on interest.
Compounding is the arithmetic process of determining the final value
of a cash flow or series of cash flow or series of cash flows when
compound interest is applied.

Sign up to view the full document!

lock_open Sign Up
Showing Page:
3/10

Sign up to view the full document!

lock_open Sign Up
End of Preview - Want to read all 10 pages?
Access Now
Unformatted Attachment Preview
Time Value of Money Time Value of Money is an important concept in financial management. It is one of the important tools used in project appraisals to compare various investment alternatives, and solve problems involved in loans, mortgages, leases, savings, and annuities. A key concept behind Time Value of Money is that a single sum of money or a series of equal, evenly spaced payments or receipts promised in the future, can be converted to an equivalent value today. Conversely, you can determine the value to which a single sum or a series of future payments will grow to at some future date. The former is called Present Value of Cash Flows and the later is called Future Value of Cash Flows. Session 4: Time Value of Money Learning Objective Explain to the learner on the concept of time value of money. Important Terms Time line Discounting Compounding Principal amount Simple interest Annuity Amortized loan Time Value of Money To make itself a valuable as possible to stock holders; an enterprise must choose the best combination of decisions on investment, financing and dividends. In any economy in which individuals, firm and governments have the time preference, the time value of money is an important concept. Stockholders will pay more for an investment that promises returns over years 1 to 5 than they will pay for an investment that promises identical returns for 6 years through 10. The decision to purchase new plant and equipment or to introduce a new product i ...
Purchase document to see full attachment
User generated content is uploaded by users for the purposes of learning and should be used following Studypool's honor code & terms of service.

Anonymous
Really helped me to better understand my coursework. Super recommended.

Studypool
4.7
Trustpilot
4.5
Sitejabber
4.4