Time value of money is an important aspect of money management. Why is it import

Question

Time value of money is an important aspect of money management. Why is it important to know what interest rates, terms of an agreement, and present value are in relationship to future value when making financial decisions? In perspective, if you won a $25 million lottery, would you take the lump sum prize of $17 million immediately or the annual annuity of $1 million dollars for the next 25 years? Your response should be based on what you know about present value and future value as well as include your personal opinion.

Explanation / Answer

Since the amount of goods we can purchase now for $1 we can not get same thing 1 year later because of inflation factor. This means the amount worth now is not same tomorrow and it value will come down.

FV= PV*(1+interest rate)^n

n= no of years

use pv formaule in excel to find the pv of amount we are going to receive in next 25 years.

pv(rate,nper,pmt,fv,type). Here assumes rate as "x%" then

17mn=pv(x%,25,10000000,,0)

using solver function we can solve and we get answer as 3.22%

Our decision is based on the interest rate we earn on the money if we receive now i.e 17mn. If you can invest at rate frgreater than 3.22% per year in next 25 years we can take lump sum prize and invest and get more return than the other case. Here the interets rate risk is also removed .

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