question archive An advertised monthly lending rate of 0
An advertised monthly lending rate of 0
Subject:BusinessPrice:2.87 Bought7
An advertised monthly lending rate of 0.9% is about 11% per year. This difference between an advertised rate and the annualized rate is based on finer TVM details that may be overlooked by borrowers. Discuss how you may have used TVM in a recent investment or loan decision and explain some of the TVM details that may have been involved in your transaction.
If you have not used TVM in the past financial transactions what practical TVM application would you expect to encounter in your future.
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Answer:
The concept of TVM (Time Value Money) is based on the idea that money today is worth more than the same amount in the future. That is because inflation makes money lose more and more of its purchasing power the more time passes. The concept of TVM is extremely useful, especially when deciding between two loans.
Time value of money is a concept which shows that value of money diminishes day by day and there are many factors which contribute to this such as inflation, rising interest rates etc. Concept of time value of money is mostly used in capital budgeting techniques such as NPV, discounting pay back etc. without this concept it is not possible to evaluate investment decisions and capital budgeting projects etc. appropriately.
Here the example of TVM (Time Value of Money) for understand the concept......
Annual cash inflows (ACI) from two competing investment (projects) opportunities are given below.
Each investment (projects) opportunities will require the same initial investment.
| Year 1 | $1,000 | $4,000 |
| Year 2 | $2,000 | $3,000 |
| Year 3 | $3,000 | $2,000 |
| Year 4 | $4,000 | $1,000 |
| $10,000 | $10,000 |
Determine the present value of the cash inflows for each investment using a 20% discount rate. This will help in understanding the time value of money concept.
Computation of PV (Present Value) of Cash flows:-
Investment X
| Year | Cash Flow | Present value factor @20% | Present value |
| Year 1 | $1,000 | 0.833 | $833 |
| Year 2 | $2,000 | 0.694 | $1,388 |
| Year 3 | $3,000 | 0.578 | $1,734 |
| Year 4 | $4,000 | 0.824 | $1,928 |
| NPV | $5,883 |
Investment Y
| Year | Cash Flow | Present value factor @20% | Present value |
| Year 1 | $4,000 | 0.833 | $3,332 |
| Year 2 | $3,000 | 0.694 | $2,082 |
| Year 3 | $2,000 | 0.578 | $1,156 |
| Year 4 | $1,000 | 0.824 | $482 |
| NPV | $7,052 |
On the basis of above it can be said that investment Y is better than investment X because its present value is higher than that of investment X. Using time value of money concept we have easily determine as which investment should be chosen, therefore time value of money concept is very important.
