According to Kuhlemeyer (2004), time value of money means that money at hand today is worth more than the same amount at a future date. It is the amount by which money will grow to in the future. In simpler terms, it is the net increase or decrease in the amount of money. He affirms that the concept helps to determine the amount that one will earn in the future.
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This concept results from the existence of charges due to the use of other people money. There are different sections under time value of money. According to Kuhlemeyer (2004), the concept of simple interest, compound interest, compounding and discounting are used to assess the time value of money.
The process of growing money from its present value to its future value at a given duration and interest rate is known as compounding. Discounting is the process of calculating how much future value of money equal to at present.
Decisions that utilized the concept of time value of money
The instance was when one of my business partners owed me money which I had lent to him as a loan. The person was reluctant to repay the money, and I took him to a law court. After the careful analysis of the evidence that I presented, the case was ruled in my favor and the judgment specified that the loan should be repaid to me.
I further made a request that the borrower should not repay the exact amount that I lent. In that instance, I was claiming that the amount I lent should be repaid with an interest. An agreement had to be entered to determine the amount of interest that was payable to me. The rate of interest was determined by considering the prevailing economic conditions, and it was determined as the prevailing market interest rate at that time.
Compounding was done on the amount that I had lent out using the market rate over the duration of time the person held my money. As a result, the amount of money that I received increased tremendously.
Computation was done using the future value annuity factor, considering that variables like principal, interest rate and duration were known. Having applied the concept of time value money, I was able to obtain extra income from that transaction. If I had claimed the original amount I had lent out, I would have obtained relatively less.
Another instance where the concept of time value of money was applied was during a rotary competition in my home country. The winners were to be awarded a total of half a million shillings. It happened that I was declared a winner among other people. As the winner claimed their money, I was reluctant since I had a decision to grow the money so that it could increase.
An agreement was entered between the rotary committee and me so that they could be paying me as an annuity at the end of every month. This was advantageous move as the money was earning me interest at the prevailing interest rate. The compounding formula was applied to determine the amount at the end of every month. If I had claimed the money as a lump sum, then I could have obtained a lesser amount than what I finally got.
Kuhlemeyer, A. (2004). Fundamentals of financial management. USA, Pearson Carroll College: Waukesha Pearson Education Limited.