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The concept of time value of money
Section:   eng » Methods of assessing the effectiveness of investme  
The concept of time value of money  The concept of time value of money based on the following basic principle:

 

"The dollar is now worth more than the dollar, which will be obtained in the future, eg one year, as it can be invested and this will bring additional revenue."

 

This principle is the most important position in the whole theory of finance and investment analysis. Based on this approach to assessing the economic efficiency of investment projects.

 

This principle gives rise to the concept of assessing the value of money over time. The essence of the concept lies in the fact that the value of money changes with time, taking into account rates of return on the money market and securities market. As the rates of return in favor of loan interest rate or rate of payment of dividends on common and preferred shares.

 

Given that the investment is usually a lengthy process, the investment practice generally is necessary to compare the value of money early in their investment with the cost of money when they return in the form of future profits. In the process of comparing the value of money in their investments and returns made to use two basic concepts: the real (present) value of money and the future value of money.

 

Future value of money is the amount which will become invested in the moment the funds over a period of time based on certain interest rate. Determining the future value of money associated with the process of compounding (compounding) the initial cost, which is a gradual increase in the deposit amount by attaching to its original amount in interest payments. In investment calculations, interest rate payments is used not only as a tool to increase the capacity value of money, but also as measuring the degree of profitability of investment operations.

 

This (present) value of money is the sum of future cash flows, given by the moment in view of certain interest rate. Determining the present value of money associated with the process of discounting (discounting), the future value of that (process) is the inverse operation of compounding. Discounting is used in many problems in investment analysis. Typical in this case is the following: to determine what amount should be invested now to get like, $ 1,000 after 5 years.

 

Thus, the same amount of money can be viewed from two angles:

 

a) the position of its true value

 

b) with the position of its future value

 

Moreover, the arithmetic cost of money in the future is always higher.

 
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