Value of Money (TVM) Shows Term Paper

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3. Future Value (of an investment)

The future value of money is the amount that it will grow to after a specified time in the future. In the previous example, the future value of $10,000 after 1 year is $10,450. In the 2nd year, the future value is $10,920.25. In the 3rd year, the future value is $11,411.66. Let's say we want to get $10,000 after 3 years (future value). Assuming that the interest rate is still 4.5%, the money that we should have right now (present value) should be $8,762.97. We can see this in the following computations:

After 1st year: $8,762.97 + 4.5% = $9,157.30

After 2nd year: $9,157.30 + 4.5% = $9,569.38

After 3rd year: $9,569.38 + 4.5% = $10,000

This further illustrates the fact that the same $10,000 in the future (3 years from now) is only worth $8,762.97 in the present (Croome 2003).

4. Opportunity cost

Opportunity cost is the economic value that is lost when an alternative choice is made. For example, let's say that you have two choices where you can invest your money. The first one is at a bank that gives 5% per year, while the second one is through bonds that give 8% per year. If you choose the first option (bank), you would have lost 8% - 5% = 3% or $30 since you could have received more if you chose the second option (bonds).

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Every investment decision incurs an opportunity cost. Most of the time, this is monetary but in some cases it is not. For example, you have the choice to work in a company or put up a business. Both choices will let you earn the same amount of money. However, if you choose to become a business owner, you will have to dedicate more time and attention. In this case, the opportunity cost is not money but additional time and effort. Opportunity cost is useful in evaluating business and investment decisions, and in determining the consequences of choosing the next best alternative.

5. Annuities and the Rule of '72

At any given interest rate, it will take a specified time for your money to double. How long this time takes is usually a subject of interest for investors. The Rule of 72 is used to determine how long it will take to double your money at a given interest rate. If the interest rate is 100%, your money will be doubled within a year. For other rates, it will take some complex computation due to compounding. In order to avoid this tedious computation, a reasonable estimate can be achieved by dividing 72 by the interest rate. The resulting value would.....

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