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BFM TVM

The Time Value of Money (TVM) is a key financial principle that asserts a sum of money today is worth more than the same sum in the future due to its earning potential. The document outlines essential components of TVM, including Present Value, Future Value, interest rates, and practical applications for financial decision-making. It also provides examples of calculating future values for lump sums and annuities, demonstrating how investment timing affects growth.

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10 views5 pages

BFM TVM

The Time Value of Money (TVM) is a key financial principle that asserts a sum of money today is worth more than the same sum in the future due to its earning potential. The document outlines essential components of TVM, including Present Value, Future Value, interest rates, and practical applications for financial decision-making. It also provides examples of calculating future values for lump sums and annuities, demonstrating how investment timing affects growth.

Uploaded by

lynnhomeaffairs
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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TIME VALUE OF MONEY

BFM360S

Abstract
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document.
When you’re ready to add your content, just click here and start typing.]

Lynn Paul
[Email address]
Introduction

The Time Value of Money (TVM) is a fundamental financial principle stating that a sum of
money has greater value today than the same sum in the future due to its potential earning
capacity. This concept is pivotal in finance and investment, as it underscores the benefits
of receiving money now rather than later.

Key Components of TVM:

1. Present Value (PV): The current worth of a future sum of money or stream of cash
flows, discounted at a specific interest rate.

2. Future Value (FV): The value of a current asset at a future date, based on an
assumed rate of growth over time.

3. Interest Rate (i): The rate at which money grows over a period.

4. Number of Periods (n): The total number of time periods (e.g., years, months)
considered.

Fundamental TVM Formulas:

• Future Value of a Present Sum: FV=PV×(1+i) n

• Present Value of a Future Sum: PV=FV / (1+i) n

Practical Applications:

Understanding TVM is crucial for making informed financial decisions, such as evaluating
investment opportunities, comparing loan options, and planning for retirement. For
instance, when considering an investment, calculating the present value of expected future
returns helps determine if the investment meets your financial goals.

Continuous Compounding:

In scenarios where interest is compounded continuously, the formulas adjust to account


for the constant application of interest. The present value (PV) of a future sum (FV) under
continuous compounding is calculated as:

PV=FV×e−rt

where e is the base of the natural logarithm, r is the continuous compounding rate, and t is
the time period.
Grasping the Time Value of Money is essential for effective financial planning and
investment strategies, as it emphasizes the importance of the timing of cash flows and the
potential growth of invested funds over time.

Understanding the Future Value (FV) concept is essential for assessing how investments
grow over time. Let's explore some practical examples to illustrate FV calculations.

1. Future Value of a Single Lump Sum:

Suppose you invest R5,000 today in a savings account that offers an annual interest rate of
5%, compounded annually, for 10 years. To determine the future value of this investment,
you can use the formula:

FV=PV×(1+I )n

Where:

• PV = Present Value (R5,000)

• i = Annual interest rate (5% or 0.05)

• n = Number of periods (10 years)

Plugging in the values:

FV=R5,000× (1+0.05)10

FV=R5,000× (1.62889)

FV = R8,144.45

After 10 years, your investment would grow to R8,144.45.

2. Future Value of Annuity (Series of Regular Payments):

Consider planning to save R200 at the end of each month for 5 years in an account that
offers an annual interest rate of 6%, compounded monthly. To calculate the future value of
this annuity, use the formula:

FV=R× (1+i) n−1

Where:

• R = Regular payment (R200)


• i = Monthly interest rate (annual rate divided by 12)

• n = Total number of payments (number of years multiplied by 12)

Calculating the monthly interest rate:

i=6%/ 12=0.5% = 0.005

Total number of payments:

n=5×12=60

Now, plugging in the values:

FV=R200× (1+0.005)60−1

0.005

FV= R200× (1.34885)−1

0.005

FV= R200 X 0.34885

0.005

FV=R 200×69.77

FV = R13,954.66FV

After 5 years, your series of monthly investments would grow to $13,954.66.

3. Future Value of an Annuity Due (Payments at the Beginning of Each Period):

If you decide to make the same R200 monthly contributions at the beginning of each month
instead, the future value calculation adjusts slightly. The formula for the future value of an
annuity due is:

FV due=R×(1+i)n−1i ×(1+i)

Using the same values as before:

FV due=R 200×(1+0.005)60−1 ×(1+0.005)

0.005

FV due = R200 69.77×1.005

FV due=R14,024.43
By making payments at the beginning of each period, your investment grows slightly more,
reaching R14,024.43 after 5 years.

These examples demonstrate how the future value varies based on the type of
investment—whether it's a lump sum or a series of regular payments—and the timing of
those payments.

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