Time Value of Money

Abstract

This topic introduces you to the analysis of trade-offs over time. Financial decisions involve costs and benefits that are spread over time. Financial decision makers in households and firms all have to evaluate whether investing money today is justified by the expected benefits in the future. They must therefore, compare the values of cash flows at different points in time. To do so requires a thorough understanding of the time value of money concepts and discounted cash flow techniques presented in this topic. This topic, therefore, shows you how to value cash flows. Understanding how to value cash flows is a fundamental skill that will be used throughout this unit and the remainder of your studies in finance. We first look at how to value a single cash flow and introduce the important ideas of compounding and discounting. Next, we consider how to value a stream of cash flows and discuss perpetuities and annuities. Finally, we explore how to value cash flows when interest rates have different compounding frequencies.