Time value of money and its main components in financing Essay

Time value of money (TVM) is the most vital concept in the finance as all financial decisions should be based on value maximization. TVM is based on the concept that a dollar received today is worth more than a dollar received a year later or in the future because a dollar received now we can do investment and earn interest therefore the value will increase. There are some key components of TVM calculations such as future value, present value, interest rate, the number of periods and periodic payment and many more.
Future value (FV)
Future value is the value that measures the future sum of money will be worth in the future based on the interest rate for a specific time. The investment can be either a single sum of money at the beginning of the year or an annuity to pay in the future or both. We can determine that the future value will be greater than the present value as money has the time value. Thus, both present value and future value are depend on the number of compounding periods involved and the going interest rate.
Present value (PV)
Present value is an equivalent amount of money today for a future payment. When comparing with other component, present value is very important as present value will allows us to understand what we will receive in future. For an instance, RM1 received in 5 years later is not equal to RM1 received now.
Interest rate (I)
When borrowing money, we will pay the interest that charge by financial intermediary. Interest rate usually will be stated as a percentage of the amount that borrower borrows and the length of the period that borrower borrowed. There are two ways of adding interest payment which are simple interest and compound interest. Simple interest is just calculated the original amount that borrower borrowed and the interest is not reinvested. On the other hand, compound interest is calculated the original amount that borrower borrowed plus all the unpaid interest accumulated to days. Compound interest is reinvested and will earned more interest than the simple interest.
The number of periods (N)
Based on time value of money, the number of periods is used to calculate the length of time available for a single cash flow which is present value to reach a certain amount which is future value. For annual compounding, we will notice how long a cash flow is going to be kept. On the other hand, for non-annual compounding which is determined the number of interest payments made throughout the duration.
Periodic payment (PMT)
Every period payment is received or paid will determined by an equal periodic payment. Based on time value of money, each payment will represent an inflow or outflow. When payment is received, this will incurred a positive amount which is an inflow. In contrast, when the payment is made, this will incurred a negative amount which is outflow. Periodic Payment (PMT) is only occurring when there is annuity payment involved.