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Knowing the time value of money


IF YOU study any formal course in finance it won’t be long before you are faced with the concept of “time value of money”.

What it means is that there is a cost to the delay in receiving money and so we say that ‘a dollar received today is worth more than a dollar received in the future’.

There are two reasons why it is better to receive a dollar today than a dollar in the future.

First, if you receive a dollar today, then you can invest it and get an additional return.

Second, there is always a risk that you will receive less than promised, or nothing at all.

So you might consider accepting 97 cents now, rather than $1.00 in a year’s time. If with certainty, you could earn three cents in interest over the year, then (taxes aside) you would be just as well off taking the 97 cents now, as waiting a year for your $1.00.

If you could pay off a loan, say a credit card, with the money received now, you might be as well off taking 85 cents now, rather than wait a year and pay credit card interest.

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Originally Published – Saturday, October 1 2016
Rockhampton Morning