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Time Value of Money

Learn present value, future value, annuities, and discounting for class problems. TVM is the foundation of every finance course and appears on virtually every exam. Once you master the timeline approach, most other finance topics become variations of the same discounting logic.

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Key Concepts

1
Present Value (PV)
2
Future Value (FV)
3
Discount rate and opportunity cost
4
Ordinary annuity vs annuity due
5
Perpetuity and growing perpetuity
6
Compounding frequency (annual, semi-annual, monthly)
7
Effective Annual Rate (EAR)
8
Rule of 72 for quick doubling estimates

Study Tips

  • Draw a timeline first
  • Match rate and period units
  • Keep sign convention consistent
  • Estimate the answer before computing

Common Mistakes to Avoid

Students mix annual and monthly rates and skip timeline setup. Always convert APR to the matching period rate before plugging into the formula. Another frequent error is using D0 instead of D1 in growing perpetuity problems.

Time Value of Money FAQs

Common questions about time value of money

Use PV when discounting a future cash flow to today and FV when compounding a present amount forward. If the question asks 'what is it worth today,' use PV. If it asks 'what will it grow to,' use FV.

Ordinary annuity payments occur at the end of each period; annuity due payments occur at the beginning. Annuity due is worth more because each payment is received one period sooner, so multiply the ordinary annuity PV by (1+r) to convert.

Divide the APR by 12. For example, 12% APR becomes 1% per month. If you need the effective annual rate, use EAR = (1 + APR/m)^m - 1, where m is the number of compounding periods per year.

Related Topics

All Finance Topics

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