December 2010
Intermediate to advanced
848 pages
31h 28m
English
Content preview from Financial Accounting: In an Economic ContextBecome an O’Reilly member and get unlimited access to this title plus top books and audiobooks from O’Reilly and nearly 200 top publishers, thousands of courses curated by job role, 150+ live events each month,
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TIME VALUE
In an environment that charges interest for the use of money, would you rather have one dollar now or receive one dollar one year from now? If you choose to receive the dollar immediately, you could lend it, and it would grow to some amount greater than one dollar after a year has passed. Someone, perhaps a bank, would be willing to pay you interest for the use of that dollar. Therefore, in a world where money has a price, a dollar today is worth more than a dollar at some time in the future. The difference between the value of a dollar today and the value of a dollar in the future is called the time value of money. For example, if the interest rate is 10 percent, $1 placed in a bank today will grow to $1.10 ($1 X 1.10) in one year. In this example, the time value of a dollar is $0.10.
Size of Time Value
Let's go one step further and explore the factors that determine the size of the time value of money. That is, what factors determine whether the time value of money is large or small? The first factor is obviously the price of money, or the interest rate. If there were no interest rate, the time value of money would be zero. Accordingly, as the interest rate gets larger, so does the difference between the value of a dollar today and the value of a dollar in the future. The higher the interest rate, the greater the time value of money. In the example above, a 20 percent interest rate would give rise to a time value of money equal to $0.20.
The second factor determining ...
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