|Appendix E||Time Value of Money|
After studying this appendix, you should be able to:
1 Distinguish between simple and compound interest.
2 Solve for future value of a single amount.
3 Solve for future value of an annuity.
4 Identify the variables fundamental to solving present value problems.
5 Solve for present value of a single amount.
6 Solve for present value of an annuity.
7 Compute the present value of notes and bonds.
8 Compute the present values in capital budgeting situations.
9 Use a financial calculator to solve time value of money problems.
Would you rather receive $1,000 today or a year from now? You should prefer to receive the $1,000 today because you can invest the $1,000 and earn interest on it. As a result, you will have more than $1,000 a year from now. What this example illustrates is the concept of the time value of money. Everyone prefers to receive money today rather than in the future because of the interest factor.
Nature of Interest
LEARNING OBJECTIVE 1
Distinguish between simple and compound interest.
Interest is payment for the use of another person's money. It is the difference between the amount borrowed or invested (called the principal) and the amount repaid or collected. The amount of interest to be paid or collected is usually stated as a rate over a specific period of time. The rate of interest is generally stated as an annual rate.
The amount of interest involved in any financing transaction is based on three elements: