Time Value of Money

Time value analysis has many applications, including planning for retirement,
valuing stocks and bonds, setting up loan payment schedules, and making corporate
decisions regarding investing in new plant and equipment. In fact, of all
financial concepts, time value of money is the single most important concept. Indeed,
time value analysis is used throughout the book; so it is vital that you understand this
chapter before continuing.
You need to understand basic time value concepts, but conceptual knowledge
will do you little good if you can’t do the required calculations. Therefore, this
chapter is heavy on calculations. Most students studying finance have a financial or
scientific calculator; some also own or have access to a computer. One of these
tools is necessary to work many finance problems in a reasonable length of time.
However, when students start on this chapter, many of them don’t know how to
use the time value functions on their calculator or computer. If you are in that
situation, you will find yourself simultaneously studying concepts and trying to
learn to use your calculator, and you will need more time to cover this chapter than
you might expect.1
When you finish this chapter, you should be able to:
l Explain how the time value of money works and discuss why it is such an
important concept in finance.
l Calculate the present value and future value of lump sums.
l Identify the different types of annuities and calculate the present value and
future value of both an ordinary annuity and an annuity due. You should also be
able to calculate relevant annuity payments.
l Calculate the present value and future value of an uneven cash flow stream. You
will use this knowledge in later chapters that show how to value common stocks
and corporate projects.
l Explain the difference between nominal, periodic, and effective interest rates.
l Discuss the basics of loan amortization.