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Compound Interest
The most important concept about understanding
any investment is the time value of money. Invested money increases in value
over time because of the growth generated from the use of production
factors such as machines, land and labor. Interest is the measure of value
of money when in use, usually expressed as annual percentage rate, or interest
rate. Discount rate is the rate
used to calculate the present value of future cash flows; also called the "capitalization
rate."
Time value of money must be considered for timberland
investment analyses. Costs for managing timberland may be spread out over the
growing period and revenue from timber sales may occur 10 or
20 years after the initial investment. In timberland investment
analyses, all costs and revenues need to be discounted to their present
value to take into account the time value of money. Discount rates
used in this situation should reflect the real borrowing cost of the project or
the opportunity cost of money, i.e. the rate of return for the alternative
best investment project.
Interest
from invested capital when reinvested will in turn become a part of capital and
earn interest, such a process is called compounding. There are four variables
involved in compounding. They are the Present Value (PV) and
Future Value (FV) of invested capital, Interest or
Discount Rate (r) and Length
of Investment (n). Their relationship can be expressed as:
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