The time value of money is important to investors in that money in hand today is much valuable than money promised in the future. Money in hand today can be used to make investments, which will earn interests and capital gains. However, money promised in the future is actually worth less today because of inflation. The time value of money can be explained using two areas, which include present value and future value.
Present value is the value of cash to be received in future. The future cash flow is discounted back to the present date using an average rate of return and time period. This concept specifies that if the future value is invested at the specified rate of return for the specified period, then it will grow to the future value. An investor wants to know what the future value is worth today to make an informed investment decision. The future value on the other hand is the value of cash flow received today in the future. It is based on capital gains or interest rate. It determines what a current cash flow could be worth in the future if it is invested at a specified interest rate and period.
Both the future value and the present value consider the compounding interest which is another important aspect for investors looking to make good investments. This concept is very informative when it comes to annuities. An annuity is money accumulated and then paid in future in phases. Organizational leaders are interested in knowing the future value of the total annuities before investing in an annuity. With the future value, they can then discount it to know what ids the present value and then make a decision to invest or not. The t y are interested in knowing whether the current price of the annuity is equal to its present value.
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