Summary Finances 2

Finances
IB YEAR 2 PERIOD 3

, TIME VALUE OF MONEY
THE ROLE OF TIME VALUE IN FIANNCE

- Time value of money: better to receive money sooner than later because you can
invest money that you have on handy today to earn a positive return (thus producing
more money tomorrow)
- Time-value-of-money analysis: compare cash today vs cash in the future; either:
- Future Value (compounding)
- Present Value (discounting) usually used by managers
- Computational tools:
- Financial calculators
- Electronic spreadsheets
- Cash flow signs
- Basic patterns of cash flow:
- Single amount; lump sum
- Annuity: stream of equal periodic cash flows
- Mixed stream: stream of unequal periodic cash flows

SINGLE AMOUNTS

Future Value: value on some future date of money that you invest today

- Compound Interest: interest that is earned on a given deposit and has become part
of the principal at the end of a specific period
- Principal: either original amount of money placed into and investment or the
balance on which an investment pays interest
- Compounding: process of adding interest to an investment’s principal and paying
interest on the new, higher balance
- FVn = PV0 x (1 + r)n
where:
FVn = Future value after n periods
PV0 = initial principal, or present value when time = 0
r = annual rate of interest (or opportunity cost)
n = number of periods that the money remains invested
- Simple Interest: interest that is earned only on an investment’s original principal
and not on interest that accumulates over time

Present Value: value in todays’ dollars of some future cash flow

- Discounting Cash Flows: process of finding present values; the inverse of
compounding interest
FV n
- PV0 =
(1+r )n