TVM is used in business for several purposes. It is used for calculating the expected return on capital projects (investments). It is also used to calculate cash flows for bonds (debt) issued or purchased.
When performing TVM calculations one must know at least 3 of the following four variables:
Interest rate, period of time, present value/future value, cash flow amount per period (payment).
Considerations given to any calculation are:
1) Whether cash flows are consistent or vary each period
2) The interest rate (discount rate)
3) Other cash flows related to the calculation
4) The units of measure (months, years, quarter) - these must be consistently applied
A TVM calculation is often used in retirement planning. Basically, one should determine the amount of money that must be saved each period to reach some pre-determined level of savings in the future (point of retirement). And then, based on some amount of cash outflow while in retirement, one has to determine how long the savings will last.
Here is an example;
If a person is 40 and has $50,000 saved now, how much must he save each month if he wishes to retire at 60 with enough money to have a monthly income equivalent to $1,000 in today's dollars that will last until he is 85?
A TVM calculation is used calculate the Present Value of an annuity that will pay out $1,000 monthly for 25 years.
A separate TVM calculation will be used to calculate how much must be saved to reach that amount in 20 years.
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