Time Value of Money (TVM)
Bank A offers to pay you a lump sum of $20,000 after 5 years if you deposit $9,500 with them today. Bank B, on the other hand, says that they will pay you an amount of $22,000 in the next five years in the event you make an investment of $10,700 with them today. Which offer should you accept, and why?
The answer to this case study question can be determined by calculating the rate of return that will be realized from each of the investments done. The decision to accept the best investment plan will be based on the venture that yields the highest returns.
Bank A’s Offer: PV = -$9,500; n=5; FV =$20,000; PMT = 0;
PV stands for present value, FV represent the future value, n shows the number of years, I denote the annual rate and PMT is the short form for payments.
Rate of return =
= 1.16054 – 1
Bank B’s Offer PV = -$10,700; n=5; FV =$22,000; PMT = 0;
Rate of return=
=1.15507 – 1
I will be lenient to make my investment in the bank that offers the highest returns. In this case we find that after comparing the two banks, Bank A has the most pleasing offer which is at 16.054% against bank B which has a rate of 15.507%.
You have decided that you will sell off your house, which is currently valued at $300,000, at point when it appreciates in value to $450,000. If houses are appreciating at an average annual rate of 4.5% in your neighborhood, for approximately how long will you be staying in the house?
PV = –300,000; FV = 450,000; I = 4.5%; PMT = 0;
PV denotes the present value, FV represent future value, I Is the symbol for the annual rate, and PMT in this case shows the payments.
= 9.21 years