The concept we are learning about this week is the time value of money.
The concept we are learning about this week is the time value of money. We have all heard that saying, “A penny saved is a penny earned”, but have you ever really thought about the meaning of the phrase? I believe it refers to this week’s concept. Time value of money is essentially the way that money grows over time when invested. In other words, receiving money now has a greater value than an equal amount later. Time value of money is important when it comes time to choose whether to invest money in that new plant and equipment or whether to introduce a new product in the market. These decisions require the use of capital allocating or capital budgeting (Block et al., 2019). Managers have to determine if the future cash flows that will be received later on will be worth the upfront investment. The discount rate is an essential part of the time value of money. Managers will use the discount rate to convert future amounts into today’s dollars. The interest rate at which a company can borrow money, what the company could earn from investing, and inflation are just a few of the factors that must be analyzed in order to estimate the future benefits of a capital investment. Future value is also used by small business owners to evaluate an investment, accounting for the current market rate of interest and the amount of time the investment will be held (Carlson, 2020). The formula to figure out the future value is FV=PV(1+i)t, where FV is the future value, PV is the present value, I is the interest earned, and t is the number of time periods. Using this formula, one can determine what the value of an initial investment will be at the end of a certain period of time. The hardest part of this process is to be accurate when choosing the interest rate to use in the calculations. It needs to be as close as possible to the real calculations in order for the company to truly know if the investment is worth the later cash flow gains.
Block, S. B., Hirt, G. A., & Danielson, B. R. (2019). Foundations of financial management (17th ed.). Retrieved from https://www.vitalsource.com/
Carlson, R. (2020). How to Calculate the Future Value of an Investment. The balance small business. https://www.thebalancesmb.com/how-to-calculate-the-future-value-of-an-investment-393391
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