Time Value of Money

Which is worth more, a dollar today or a dollar tomorrow? Or, put another way, is it better to have a dollar today or a dollar tomorrow?

As consumers, we have a natural desire to have money right now. We have a disposition to value having money today over having money tomorrow. But there are actually other reasons why a dollar today is worth more than one tomorrow.

Having a dollar right now gives me options about what to do with that dollar. I can spend it, yes, but I can also invest it. If I invested it, that dollar would be worth more in the future, as my investment grows. So at a 5% interest rate, if I had $100 now, it would be the same as if I had $105 in a year. In that example, $100 now = $105 later.

Of course, interest rates aren't the only thing that affects the value of money. While interest is making your money grow, inflation is eating away at the true value of that money. This is why investing in low-paying investment won't really earn you anything in the long run. The purchasing power of your money will not grow.

Right now, bank CDs are paying very low interest rates. Well below the rate of inflation. Putting money into a CD will actually cause your purchasing power to decrease. So when considering investments, do not only look at the rate, but consider the future value of your money and how your decisions today affect your overall purchasing power.

Things to think about (2)

1.   Thomas Franklin arrived at the following tax information:

Gross salary, $46,660

Interest earnings, $225

Dividend income, $80

One personal exemption, $3,400

Itemized deductions, $7,820

Adjustments to income, $1,150

What amount would Thomas report as taxable income?

34,595

2.   What would be the net annual cost of the following checking account? 

Monthly fee, $3.75; processing fee, 25 cents per check; checks written, an average of 22 a month.

$111

     

     

3.   What would be the average tax rate for a person who paid taxes of $4,864.14 on a taxable income of $39,870?

12.2%

4.   A payday loan company charges 4 percent interest for a two-week period.  What would be the annual interest rate from that company?

104%

           

5.   What is the annual opportunity cost of a checking account that requires a $350 minimum balance to avoid service charges? Assume an interest rate of 6.5 percent.

$372.75

Things to think about (1)

1.      Ben Collins plans to buy a house for $65,000. If that real estate property is expected to increase in value 5 percent each year, what would its approximate value be seven years from now?

91455

2.      At an annual interest rate of five percent, how long would it take for your savings to double?

14.4 years

3.      In the mid-1990s, selected automobiles had an average cost of $12,000. The average cost of those same motor vehicles is now $20,000. What was the rate of increase for this item between the two time periods?

60%

4.      A family spends $28,000 a year for living expenses. If prices increase by 4 percent a year for the next three years, what amount will the family need for its living expenses?

31496.20

5.      What would be the yearly earnings for a person with $6,000 in savings at an annual interest rate of 5.5 percent?

$330

6.      Elaine Romberg prepares her own income tax return each year. A tax preparer would charge her $60 for this service. Over a period of 10 years, how much does Elaine gain from preparing her own tax return?  Assumes she can earn 3 percent on her savings.

687.83

7.   Tran Lee plans to set aside $1,800 a year for the next six years, earning 4 percent.  What would be the future value of this savings amount?

       11939.36

8.   If you borrow $8,000 with a 5 percent interest rate to be repaid in five equal payments at the end of the next five years, what would be the amount of each payment?

            1848

9.   Based on the following data, compute the total assets, total liabilities, and net worth.

Liquid assets, $3,670                               Household assets, $89,890

Investment assets, $8,340                        Long-term liabilities, $76,230

Current liabilities, $2,670

Assets: 101900

Liabilities: 78900

Net worth: 23000

10. Which of the following employee benefits has the greater value?  (Assume a 28 percent tax rate.)

A nontaxable pension contribution of $4,300 or the use of a company car with a taxable value of $6,325. 

The nontaxable pension has an after tax value of 5972.23 (4300/(1-.28)). Since this is less than the 6325 value of the car, the car has the greater value.