Time value of money

THE VALUE OF MONEY RECEIVED TODAY IS MORE VALUE THAN MONEY RECEIVED IN FUTURE

TIME PREFERENCE OF MONEY

TWO OPTIONS RECEIVE IMMEDIATELY AFTER ONE YEAR - Rewarded interest rate

Two assets
Intial investment project a 15,00,000 project b 15,00,000

Expected cash inflows I year II year III year

3,00,000 6,00,000 3,00,000 6,00,000 9,00,000 3,00,0000 ---------------------------------------- 15,00,000 15,00,000

 Money has time value. A rupee today is more valuable than a rupee a year hence. A rupee a year hence has less value than a rupee today. Money has, thus, a future value and a present value.

Techniques for calculating time value of money

compounding to find future value discounting to find present value

Compounding techniques
Future value relies on compound interest to measure the value of future amounts. When interest is compounded, the initial principal/deposit in one period, along with the interest earned on it, becomes the beginning principal of the following period and so on. Interest can be compounded annually, semiannually (half-yearly), quarterly, monthly and so on.

Compounding formula to calculate future value

Basic formula of compounding: Fv = P (1 + i)n Fv = amount P= principle I = interest rate N = no of years

 Mr kavin deposits rs 20,000 for 3 years at 10% interest . What is the compounded value of his deposit

Present value
Present value represents an opposite of future value. The present value of a future amount is the amount of money today equivalent to the given future amount on the basic of a certain return on the current amount.

 The interest factor formula and the basic equation of the present value are (i) Basic formula: [FV/(1 + i)n]

PRESENT VALUE
CALCULATE THE PRESENT VALUE OF CASH INFLOWS YEAR EXPEXTED CASH INFLOWS 1 3000 2 4000 3 5000 4 6000 5 7000