Time Value of Money Essay Example | Topics and Well Written Essays - 750 words

Time Value of Money - prove ExampleTherefore, to make a certain investiture, the opportunity costs should be low (David, 1984).Time think of of money sh bes a direct relationship with the prevailing worrys in a market. As the interest evaluate rise, the hold dear of a sawhorse today bequeath rise accordingly. When the interest rates follow the decrease pattern, the value of money also sees a down sliding. This is because the interest rates play a very important part in determining the future value of a lump summation or the symbolise value of a future lump sum it is dependent on the interest rate. Therefore, they are directly related to each other.There are many other aspects which are related to the cartridge holder value of money. The future value of an amount of money sack up also be calculated retentivity in mind the clock value of money. Making it straightforwardr, the future value of a dollar is the dollar or any other amount that it earns with the help of an in terest over a period of time (David, 1984). For example, if $1000 are invested today for an year at 5% interest rate, after an year it get out give us $50 dollars and the total received would be $1050. However, if the same amount is invested in the pine run for years, compounding will take place and at the end of second year, the interest will be earned on $105. This compounding will go on for the number of years the enthronisation is made. If P is considered the principle amount of money that is invested, i is termed as the interest rate at that time, thus the future value of a dollar would be given as P(1+i). When compounding for two years, the comparability changes to P(1+i)(1+i) or,FV=P (1+i)nWhere P is the principal amount, i is the interest rate and n is the periods for which the investment is made. With increasing interest rates, the future value also keep on increasing. With changing interest rates, the above formula would be applied separately for the different rates. Present ValueThe present value of a future investment can also be calculated keeping in mind the time value of money. The present value of a future investment is the current value of that payment that is to be received in the future. Discounting is the process that is employed in this case. This is the opposite of finding the future value of a present sum (Gary, 1978). Simply, it is calculated by dividing the future value with the same interest factor which was multiplied in the first case. PV=FV/(1+i)nWhere FV is the future value, PV denotes present value, and (1+i)n is the interest factor. In finding out the present value, discounting is being done, therefore, this concept shares and contrary relationship with the time value of money. As the interest factor that determines the time value of money is divided, the value of the present value decreases resulting in the inverse relationship. Opportunity CostsOpportunity costs are the benefits that a person is giving away in spending the money in a certain course of way. In other words, it is the benefit lost in choosing one alternative over another alternative. For this to be true, the opportunity costs should be really low for an alternative to be chosen. Higher the opportunity costs, lesser are the chances that the alternative may be chosen by a risk aversive personality. It can be termed as the basic relationship that exists between shortage and selection.Rule of 72Rule of 72 is a simple mathematical shortcut that is used in finance in order to find out when