04/06/2021 Time Value of Money Notes - BBA|

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IME VALUE OF MONEY

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Basic rule of Time value of Money

“Money received today is Worth more than the same money received in the future”
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Time Value of Money -

Shareholders of a business make sacrifices by investing funds into the business now,
to reap its benefits in the future, either as dividend along the years or increase in
share prices in the future. However, the expected future benefits are uncertain and
therefore they expect a return on invested capital to compensate for the waiting
period. A rational investor will chose to invest the money elsewhere or consume it if
he is not adequately compensated.

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A similar situation arises in case of acquisition of assets by a firm. A firm requires
immediate cash to acquire an asset today but the benefit from the asset will be
received in the future. This affects the future cash flow over the life of asset. This
leads to the study of time value of money.

While taking financial decisions a financial manager compares the present value of
total cash inflows with the total cash outflows associated with a project/proposal to
determine its profitability.

Concept of Time Value of Money

The actual worth of money available at present time is more than its worth in the
future due to potential earning capacity of money.

Therefore, given a choice of receiving a certain sum of money today or in the future,
a rational person will always choose to receive the money now as it has more value • Advertising Management (20)

today than in the future. This phenomenon is known as time preference of money. • Articles (270)
• Banking and Insurance (22)
• Blog (39)
Reasons for Time preference of Money - • Business & Entrepreneurship (6)
• The future is uncertain and involves risk. • Business Communication (1 5)
• People prefer to satisfy present needs as compared to future goals. • Business Environment (21)
• Business Ethics (2)
• Due to potential earning capacity of money as the same money can be invested
• Business Law (1)
elsewhere and different opportunities can be explored.
• Business Statistics (49)
• Company Law (1 4)
Components of Time value of Money — • Computer Applications (9)
• Consumer Behaviour (22)
• Present Value (PV)
• Cost Accounting (3)
• Future Value (FV)
• E-commerce (8)
• Interest — Simple or Compound (i) • Entrepreneurship (1 1)
• Amount (A) • Financial Accounting (2)
• Annuity — Fixed amount of money received/paid for a particular period of time. • Financial Management (29)
• Time Period — (n) • Financial Services (19)
• Perpetuity — An annuity with infinite time period. • Human Resource Management (18)

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• Income Tax (2)
• International Business (13)
Valuation concepts - • Investment Analysis & Portfolio Management (11)
• IT & Technical Skills (5)
Single cash - • Macro-Economics (9)
• Management Accounting (18)
FV = PV (1 +i)’ • Management Information System (4)
• Managerial Economics (2)
PV = FV ( 1/1+i)" • Marketing & Advertising (7)
• Marketing Management (18)
Annuity - • Marketing of Services (6)
• Micro-Economics (2)
FV = A ( (1 +i)" — 1/ i } • Operations Management (2)
• Organizational Behaviour (7)
PV = A {(1 +r) n — 1/ i(1 +r)’ } • Personal Finance (2)
• Principles of Management (9)
Perpetuity - • Project Management (11)
• Projects and Presentations (34)
PV of Perpetuity = Annual cash flow or installments(A) • Public Finance (11)
• Research Methodology (9)
• Rural Marketing (1)
Conclusion - Time value of money encourages a person to receive money now • Strategic Management (14)

instead of waiting to receive it in the future but his preference to consume money • Uncategorized (1)

now may change if he is duly compensated for the waiting period.

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