Time Value of Money
The phrase
time value of money
(TVM) describes calculations based on
cash flows (money received or money paid) earning
compound interest
over a period of time.
Compound interest
calculations take into account
that interest, added to the principal at specified compounding periods,
also earns interest. Many financial problems are TVM problems-for
example, savings accounts, mortgages, pension funds, leases, and
annuities.
The TVM equation is:
(px100+I-F)x(1+I+100)A-N-px100+I=B
where
B
=
the
beginning value
(also called the
present value)
of
the series of future cash flows. To a lender or bor-
rower, B is the amount of the loan; to an investor, B is
the initial investment. B always occurs at the begin-
ning of the first period.
F
the
future value-the
amount of the final cash flow,
or the compounded value of the series of previous
cash flows. F always occurs at the end of the last
period.
I
the periodic interest rate, expressed as a percent. For
example, if an account earns 10% annual interest,
compounded monthly, its periodic rate is
10/ 12 ,
or
0.8333%
N
the total number of payments or compounding peri-
ods. N can be expressed in any unit of time-for
example, years, months, or days.
*
P
amount of each periodic payment. The payments are
the same amount, and no payments are skipped.
Payments occur at the end of each period.
• When
I
SOLVE
I
calculates a non-integer N, the answer must be interpreted carefully, since
the equation does not calculate partial period payments. Calculations using a stored non-
integer N produce mathematically correct results, but the results have no simple useful
interpretation.
7: The Equation Library
109