This paper involves two short essays and a series of calculations. The first short essay involves the definition of the time-value of money. The second short essay addresses why a financial manager should understand the importance of the time-value of money. The equations ask one to calculate present value, future value, and annuity values.
¶ … Value of Money
I would define the time value of money as the value of what that money could be earning between the present day and the future time that one could have the same amount of money. In addition to the financial earnings, I would factor in opportunity costs to my calculation of the time value of money, because it is important to consider what opportunities, not simply earning opportunities but general opportunities, one would miss by not having that money available in the present time. In other words, the time value of money is what one will have to make in the future to replace the money that is missing now combined with the opportunities lost in the interim.
It is critical for financial managers to understand the concept of the time value of money, because it is the whole concept behind financial planning. Many people who seek out financial managers are high earners, but they are also high spenders. They want to be able to afford the trappings of an affluent lifestyle, and, because of their significant earning power, it can be very difficult for them to understand that the income stream is not going to be continuous throughout their lives. In fact, many of them may approach a financial manager with the knowledge that their income streams are likely to continue to increase for the foreseeable future, so that they are not prepared to save enough of their money to provide them with their desired lifestyles upon retirement. That is why a financial manager not only understanding the time-value of money, but also being able to explain it to a client can be critical.
The most critical thing that a financial manager can do is help a client understand the amount of money that he needs to retire, and then demonstrate how to build up that wealth prior to retirement age. By demonstrating the time value of money, the financial manager can demonstrate that there is a significant difference between $100 saved towards retirement today, in 10 years, in 20 years, or simply upon retirement. All three of those present-day dollar amounts, at that time, will have significantly different values upon retirement. This can help a financial manager explain why some so-called discretionary funds should be redirected from present-day expenses to savings. This is an important lesson, because many people assume that they can begin their retirement savings when they make more money, without considering that inflation costs and other cost-of-living adjustments (growing children, college accounts, increased health expenditures) may already require devotion of those extra resources, and that the later they wait to do their saving, the greater the amount of present-day dollars that they will have to save in order to have the same amount of money at a projected target date. A financial manager must be able to explain this concept to people, and to get them to buy into this concept without feeling penalized by savings.
3) Calculate the future value of the following showing work:
PV=FV / (1+r) t
PV * (1+r) t = FV
FV= PV * (1+r) t
a. $54,298 if invested for five years at a 7% interest rate
FV= PV * (1+r) t
FV= $54,298 * (1+.07)5 = $76,155.75
b. $99,112 if invested for three years at a 4% interest rate
FV= PV * (1+r) t
FV= $99,112* (1+.04)3 = $111,487.52
c. $121,124 if invested for seven years at a 2% interest rate
FV= PV * (1+r) t
FV= $121,124 * (1+.02)7= $139,236.78
d. $929,129 if invested for ten years with a .9% interest rate
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