Time Value of Money:
Time value of money relates to the importance of having cash at hand today as opposed to the future. Mathematics of time value of money quantify the value of money be it in dollars, pounds or any other currency depending on the rate of return an investment earns. There are various reasons as to why cash at hand is preferable to future cash (Silver, 2011).
The availability of investment opportunities at present: Opportunities do come ones in a lifetime. If an investment opportunity were available now, cash that is at hand would be essential in making that investment. However, if the available cash is held up elsewhere and probably making minimal or barely any returns, one stands to lose since the reality is that that investment may probably not be there when the money is available for use (Silver, 2011).
Concept of uncertainty: Future cash is never guaranteed. Majority of all investment opportunities come with risks that at times involve the investor losing all his investment, thereby making no returns (Silver, 2011). On the other hand, there is usually no guarantee that the investor will still be alive to enjoy the benefits of his or her investment when they mature.
Inflation: Inflation, which simply put is the general increase in prices, has the ability to lower the purchasing power of money in the future. By so doing, the value of money now as opposed to the future, where it may have a low purchasing power, is more valuable.
Time value of money is thus a vital concept used in making decisions that involve the value of money at present and in the future. It is used in various areas such as capital budgeting, preparation of loan amortization schedules, evaluation of securities, determination of cost of capital and various other areas (Silver, 2011).
Ordinary Annuity Investment:
An annuity is a continuous series of payments over a given period. An ordinary annuity is series of equal payments made at the end of each period for instance annual end. An ordinary annuity investment is thus an investment that generates equal revenues at the end of each given period for the duration of the investment (Megginson & Smart, 2008).
Advantages of an ordinary annuity investment:
Tax deferral: Annuities are tax deferred and as such grow free of tax up until the moment the investor will withdraw the money. As such, it stands as a preferred method of investment (Kinney & Raiborn, 2008).
Guaranteed payout: Annuities have a guaranteed return. The annuity holder usually receives a certain amount of money at a given period during the annuity’s duration (Kinney & Raiborn, 2008).
Protected from creditors and probate: Annuities are in most cases free from creditors and as thus they cannot claim refunds from ones annuity. They are also exempt from probate proceedings (Kinney & Raiborn, 2008).
Disadvantages of ordinary annuity investment:
Complexity-Annuities regardless of their benefits are a difficult form of investment to understand. Hence it makes it even more difficult to educate potential investors on how the investment works and most may thus end up seen it as a complex investment hence fear making an investment (Kinney & Raiborn, 2008).
IRS rules pose a restriction as to how one takes out money from an annuity. There is also the fact that any withdrawal that is not the principal i. e. a withdrawal that is considered as a return of the annuity investment is taxed as ordinary income (Kinney & Raiborn, 2008).
Future Value of the annuity:
F. V. of annuity= Annuity * (1+rate of return) ^n-1
=$10, 000 * (1+0. 05)-1
F. V. of annuity=$55, 256. 3125
Present Value of the investment
Present Value = Future Value * 1
P. V. = $140, 000 * (1+0. 06) ^-12
P. V. = $69, 575. 7109
The Investment cannot be doubled. For the investment t be doubled it should have a present value of $70, 000. However, the present value in this case totals to $69, 575. 7109.
Kinney M. R. & Raiborn C. A. (2008) . Cost Accounting Foundations and Evolutions: Foundations and Evolutions. Cengage Learning, Jan 1, 2008
Megginson W. L. & Smart S. B. (2008). Introduction to Corporate Finance. Cengage Learning EMEA, 2008
Silver T. L. (2011). The Time Value of Life: Why Time Is More Valuable Than Money. i Universe, Jun 16, 2011