The concept of time value of money states that the money you have today is worth more than the expectation that you will receive money in the future (Bierman, 2010). The money that a person holds today has more value because he/she can invest it and earn interest. I have used TVM in my past financial transaction. When I was working in a local company, I received a bonus due to my outstanding performance. However, my boss gave me two options, and I was to choose the one that would benefit me. In the first option, I was to receive $10,100 bonus now while in the second option, I was to receive $10,900 bonus after one year. When choosing the options, I had to consider the inflation rate of 5% per year and bank’s interest rate of 12% per annum.
The first option gave me a choice to receive the bonus earlier than the second option. I took the first option because I was able to buy more with $10,100 at that time than with $10,900 in the future due to the inflation rate of 5%. Second, the first option gave me the chance to invest the money in the bank and earn an annual return of 12%. Using the discount rate of 12%, future values of both options were as follows. The first option encompassed the amount of bonus and discount rate of 12% while the second option had the amount of bonus only. The first option earned me a higher future value of $11,312 while the second, option maintained its value of $10,900. Therefore, based on the two future values, I preferred the first option because of its highest future value.
Bierman, H. (2010). An introduction to accounting and managerial finance: A merger of equals. Singapore: World Scientific.
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