- Do your own Finance homework. Just kidding…
- There is not always value in having money now. There are variables to consider, such as inflation, opportunity cost, risk-free return, expected return. If I offered you $2,000 today, or $2,200 one year from now, which option would you choose? Depends on what utility you can get from that $2K today and if you can do better than 10% interest per year. 3. On the other hand, if you are broke and need to buy food now, $2,200 a year from now is meaningless. You would take the $2K now.
You can’t abstract the concept from real world application. Time value of money is a concept that allows you to compare alternate scenarios. For example, is it worth paying more points for a mortgage to get a lower interest rate?
What business leverages the time value of money? Any business offering zero percent financing. It is conceivably less expensive overall (discounted cash flows) to pay interest on a loan and get a discounted purchase price than it is to pay a higher purchase price at zero percent interest.
And that’s another part of the analysis. You have to look at the present value of future cash flows to do a complete analysis.
Some bond prices are based on the expected future value of the bond. Some bonds are priced below face value and pay their full face value at maturity. The difference between the purchase and redemption prices is the interest earned on the bond. Bond traders use this fact to sell bonds at a value higher than their face value when the interest rate on the bond is greater than the current risk-free market interest rate. Same concept as time value of money.
I knew that MBA would come in handy someday…
– Z –