Time Value of Money (TVM) Paper

Essay by inspirationalB, May 2008

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There is one basic premise about money that all financial experts agree upon. Money on hand today is worth more than money received in the future because money today can be invested to earn interest to yield more money in the future. The time value of money quantifies the value of money over time. The time value of money depends upon the rate of return or interest rate that can be earned by investing the current money on hand.

Before a person decides to make a financial investment, or a business decides to repay or restructure long term debt, the concept of "opportunity cost" should be understood. Opportunity cost is the variation of the performance of an investment and a preferred venture adjusted for fixed costs and other costs. The opportunity cost of capital is the expected return relinquished by bypassing of other possible investment activities for other money. To further explain, it is the expected return that is forgone by investing in a project rather than in comparable financial securities.

The finance professor states, that "When we are dealing with the time value of money we are interested in compound interest. Compound interest is when your interest earns additional interest; simple interest is when only the original principle earns interest. The basic idea of time value of money is that a dollar today is worth more than a dollar tomorrow. That is you would rather have a dollar now than later." (2007)Who wouldn't want to pay later? To illustrate this point, "money today allows you to buy some goods immediately." (Alternatively you may be willing to forgo current consumption and wait until later to purchase your goods. Thus you could lend your "goods money" to another investor / consumer with assurance that some time at a later date, you...