11.26 Summary: The Time Value of Money
Virtually everything one does in the finance discipline involves, at some level, the time value of money. It is central to all of financial analysis and must be mastered. It is a basic tool.
In the prior two chapters, we developed a rationale for assessing “simple” future- and present-values. We defined the two qualifications for a cash flow series’ being categorized as an annuity, and then defined an ordinary annuity as the sum of the series’ present- and future-values. We further defined “annuities due” and outlined a means for converting an ordinary annuity into an annuity due. Additionally, we determined how interest rate tables may be used as a shortcut tool for calculating the time value of money.
Then we assessed uneven cash flow series that do not qualify as annuities. We examined two cases of perpetuities (no-growth and growth) as a special case of annuity. We examined fractional time periods and discovered the arbitrary nature of certain time value calculations, which have to do with the varying conventions regarding the definition of “period” and the use of interest rates in this regard. Finally, an illustration of a mortgage was presented and evaluated.
“Before one continues further in this text, it is imperative that the student master fully the critical concept of time value of money in all its variety.”