Time_Value_of_Money

Time Value of Money QRB/501 Professor Anthony Mafias University of Phoenix August 13, 2012 Abstract Time Value of Money also known as TVM involves the exchange of something of value (money) at different points of time. TVM in the investment arena money is exchanged for the future cash flow associated with the investment. This paper will explore the four primary reasons the value of money depreciates if not received immediately. Time Value of Money is determined using analysis and formulas that solve the TVM problems in various situations. Time Value of Money problems have six basic types that are separated by cash flow conversion, single or repeated values, and variables. This paper will explore how the TVM is used in the financial environment and give two examples of its application. Time Value of Money According to Investopidia.com, time value money also called TVM is the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received. In the financial environment Time Value of Money is used in all investments. Single standard of value is determined on various sets of products and services. The passage of time between outflow and inflow determines the current value associated with cash flow that occurs at various times. When cash flow occurs and determining if the flow is positive or negative, makes it possible to assess the investment. The four primary reasons why a dollar received in the future is worth less the dollar received immediately. The first reason is positive rates of inflation. The positive rate of inflation over time reduces the purchasing power of the dollar. The second reason is because of the cost of lost earnings. The lost cost of earning is suggest that the money could be worth more today if it were invested and given the opportunity to earn a return today as opposed to the future. Thirdly, future is only a promise or prediction and contains uncertainty. Risk, default and nonperformance of investments are reason people hesitate to invest and tend to hold on to money. A common saying is, “a dollar in hand today in worth more than an expected dollar in the future (Herrick, B.J., 2000, p.1). Finally, because humans are impatient, they prefer to have money in hand today instead investing and hold out for an uncertain promised return. Time Value of Money problems differ in form and situation. The most important characteristics are the direction in time in which cash flow is converted to equivalent values, whether the cash flow is single or in a series, and the decision or the unknown value of the problem. There are many variants of time value of money problems, the majority is placed into six categories. 1. Single-Payment Compound Amount (SPCA) SPCA problems is used when a known initial outlay invested at a specific interest rate and compounded at a regular basis. SPCA is also used when an investor must know the growth over a specific period time. Examples: Savings Deposit Account, Known interest rate savings bond. 2. Uniform Series Compound Amount (USCA) Interest bearing account or interest paying investment that permits interest to be reinvested. Example: Determining the size of a retirement account, if monthly deposits are made into an interest paying investment account, College expense account, and Life insurance policies. 3. Sinking Fund Deposit (SFD) Regular deposits are made that will generate a predetermined amount by the end of a given period. Example: College education- deposits start at birth until the child turns 18. $30.000 is the goal. Determine the necessary amount to be deposited to reach the desired goal. 4. Single-Payment Present Value ( SPPV) SPPV calculates discounted value for future single payments that are equivalent to today value exchange. Example: Pure Discount Bond 5. Uniform- Series Present Value (USPV) USPV is total series being sought for a series of payments of equal size to be received at various times. Example: Fixed payments yearly for five years, retirement payments. 6. Capital Recovery (CR) CR is also known as the loan amortization payment problem. Present value and principle is known, payment amount that will cover both loan repayment and interest owed. Example: Property Mortgage, Car Loans. Each solution must include two necessary phases, 1. correctly identify the type of problem exists and the known factors, 2. Correctly apply the accurate mathematical calculations to find the solution. Te easiest way to find the solution is to categorize the known and unknown values and ruling out which approach does not apply. Two examples will be given that will show information gathered to determine if a specific property is a good property investment and a stock investment to determine if in five years the property and stock will yield a profit. 410 Willow Circle is the property chosen for purchase. Capital Recovery will be the problem used because the present and value and the principle is known and the loan repayment and interest owed will be included in the mortgage amount. The property chosen will be purchased as a yearly lease property and the property is located in a prime location in West Palm Beach, FL minutes away from downtown. With $10,000 to invest, I will use $7,000 as a down payment and the remaining will be used for upgrade and repairs. Example 1- Property Information according to Zillow.com, 410 Wilma Circle APT. 305, West Palm Beach, FL. Sale Price: 82,900 Estimate: $76,902 Est. Mortgage: $297/month. 2 Bed/2Bth Single Families Home Built in 1973, 936 soft, Last Sold” Nov. 2011 for 45,500. Figure 1- 5 year Growth Chart Fig. 1 Example # 2 Proctor & Gamble has been in business since 1890. P&G has had consistent dividend increase for the past 122 years. In June 2012, P&G reported a 7% dividend increase. Proctor and Gamble is a consist company and according to the last year’s growth, and the projected 5-year margins, Proctor & Gamble is a safe investment. Proctor & Gamble Stock Price per Share: $56.05 and I will purchase $10,000 dollars of Proctor & Gamble Stock. Growth Last Year’s Growth: Figure 2. Figure 3. Time Value of Money is money available today is worth more than the same amount in the future due to its potential earning capacity. The value of money depreciates over time and the value is determined using formulas and problems. Inflation, cost of lost and future uncertainties makes the need for variables, and value problems necessary to determine the possibility of investments yielding a high return. A common saying is, “a dollar in hand today in worth more than an expected dollar in the future (Sherrick, B.J., 2000, p.1). As stated earlier, humans are impatient and depending on how much money and individual has to invest, they would rather hold on to it and have it gain slow earning interest, rather than do a unsure investment. References Investopedia.com http://www.investopedia.com/terms/t/timevalueofmoney.asp#ixzz22oZy5w6U Bruce J. Sherrick, P. N. (2000, September). Time Value of Money and Investment Analysis V 1.2. Retrieved August 10, 2012, from Explanation and Spreadsheet Applications for Agricultural and Agribusiness Firms Part I: http://www.agmarketing.extention.psu.edu/.../TimeValueMoneyP1.PDF Solve Problems Related to Present value (PV) and Future Value (FV). (n.d.). Retrieved August 10, 2012, from BYU Marriot School: http://www.personalfinance.byu.edu/'q+node/442 Zillow.com http://www.zillow.com/homedetails/410-Wilma-Cir-APT-305-West-Palm-Beach-FL-33404/46874571_zpid/ Proctor & Gamble.com, http://www.pg.com/en_US/index.shtml