TIME VALUE OF MONEY

V.K.OVIYA - 2019701524
RITHIKA.C - 2019701529
CONTENTS:
❏ Definition:
❏ Time value of money
❏ Reason for time value of money
❏ Importance of time value of money
❏ Techniques of time value of money
❏ Methods of calculating future value
❏ Calculations based on time value of money
❏ Notations
❏ Formulas
❏ Future value calculation
❏ Present value
❏ Time value calculation using table
❏ Benefits of the knowledge of time value of money
❏ Conclusion
DEFINITION:

Time value of money is the premise that an investor prefers

to receive a payment of a fixed amount today, rather than an
equal amount in the future, all else being equal.
Time value of money :

❏ The time value of money (TVM) is the idea that money available at the present time
is worth more than the same amount in the future due to its potential earning
capacity. This core principle of finance holds that, provided money can earn
interest, any amount of money is worth more the sooner it is received.

❏ Time Value of Money (TVM) is an important concept in financial management. It can

be used to compare investment alternatives and to solve problems involving loans,
leases, savings.

❏ TVM help us in knowing the value of money invested. As time changes value of
money invested on any project/ firm also changes. And its present value is
calculated by using “mathematical formula”, which tell us the value of money with
respect of time.
Reason for Time value of Money:
There are certain reason which determine that money has time value following are the reason;

❏ Risk and Uncertainty – As we know future is never certain and we can’t determines the
risk involved in future because outflow of cash is in our hand as payment whereas there
is no certainty for future cash inflows.

❏ Inflation - In an inflationary economy, the money received today, has more purchasing
power than the money to be received in future. In other words, a rupee today represents
a greater real purchasing power than a rupee in future.

❏ Consumption - Individuals generally prefer current consumption to future consumption.

❏ Investment opportunities - An investor can profitably use the received money today to
get higher return tomorrow or after a certain period of time.
Importance of Time Value of Money:

❏ In Investment Decisions - Small businesses often have limited resources to invest in

business operations, activities and expansion.
One of the factors we have to look at is how to invest, is the time value of money.

❏ In Capital Budgeting Decisions - When a business chooses to invest money in a project -

such as an expansion, a strategic acquisition or just the purchase of a new piece of
equipment
- it may be years before that project begins producing a positive cash flow.
The business needs to know whether those future cash flows are worth the upfront
investment.
Techniques of time value of money:

There are two techniques for adjusting time value of money.

They are:

❏ Compounding Techniques/Future Value Techniques The process of calculating future

values of cash flows. In this concept, the interest earned on the initial principal amount
becomes a part of the principal at the end of the compounding period.

❏ Discounting/Present Value Techniques The process of calculating present values of cash

flows.
Methods of calculating future value:
❏ Compounding. - It is the process of finding the future values of cash flows
by applying the concept of compound interest.

❏ Compound interest. - It is the interest that is received on the original

amount (principal) as well as on any interest earned but not withdrawn
during earlier periods.

❏ Simple interest. - It is the interest that is calculated only on the original

amount (principal), and thus, no compounding of interest takes place.
Calculations based on the time value of money:

❏ Present Value (PV)

of an amount that will be received in the future.

❏ Future Value (FV)

of an amount invested (such as in a deposit account) now at a given rate of interest.

❏ Present Value of an Annuity (PVA)

❏ Future Value of an Annuity (FVA)

NOTATIONS:
❏ PV (Present Value) is the value at time = 0

❏ FV (Future Value) is the value at time = n

❏ ‘r’ is the rate at which the amount will be compounded each period

❏ ‘n’ is the number of periods

❏ PV(A) the value of the annuity at time = 0

❏ FV(A) the value of the annuity at time = n

❏ ‘A’ the value of the individual payments in each compounding period

Formulas:

❏ Present value of a future sum / Future value of a present sum:

❏ Present value of an annuity:

Time value of money::
❏ Consider 2 situations

❏ Option A : You receive Rs. 10,000 today.

❏ Option B : You receive Rs. 10,000 in 3 years time

❏ Assume no inflation

❏ Assume interest rate 10% (Compound Interest)

❏ Assume no change in any other financial situation

Future Value Calculation:
❏ Consider Option A

❏ Let’s calculate the future value of Rs. 10,000 received at the present time
Present Value Calculation:

Similarly using the equation as

the present value of Rs. 10,000 received in 3 years when the interest rate is 10% can be
calculated as Rs. 7513.1
Time Value of Money:
Time Value Calculations using Tables:
Benefits of the knowledge of the time value of money:

❏ For investment analysis – To decide the financial benefits of projects

❏ To compare investment alternatives

❏ To analyze how time impacts business activities such as loans, mortgages,

leases, savings, and annuities.
Conclusion:
❏ By all the above discussion we get to know about the value of money with respect
to time.

❏ We learn the importance of TVM how it will help in making different decision which
will provide profit to firm.

❏ We get to know how future value and present value of money is calculated.

❏ What are different techniques and methods for calculating TVM.

❏ How comparison between different project is done by the firm on the basis of
return.