Time Value of Money

TIME VALUE OF MONEY

Time value of money means that worth of rupee received today is different from the worth of rupee to be received in future. This preference for current money as against future money is known as the Time Preference for Money or Time value of Money.

REASONS FOR TIME VALUE OF MONEY

There are several reasons for the computation of time value of money, some of them are as follows:

01. Risk and Uncertainty

Risk and uncertainty of the money which is receivable in future is the main reason for calculation of the Time Value of Money. The risk and uncertainties can be assessed through the computation of time value of money.

02. Preference for consumption

The preference for consumption of money in the current period to future period by the people is also the reason for the importance of time value of money.

03. Investment Opportunities

The investment opportunities which are having more returns also lays an emphasis on calculation of the time value of money to make suitable decisions according to the return expected and risk-bearing capacity.

04. Inflationary Economy

The constant increase in the prices of the goods and services every year results in inflation and because of inflation, the value of the money decreases that means we get less amount of goods for the same money when compared with last year prices.

TECHNIQUES FOR TIME VALUE OF MONEY

01. FUTURE VALUE (compounding Concept)

Future value of money is the concept which is focused on the future receivables for the current asset or investment. It is the value of a current amount at a specified date in the future. The future value is based on the compound interest and assumed rate of growth every year. The future value is calculated as follows:

  • Future value of a single cash flow
  • Future value of a series of cash flows
  • future value of multiple flows

02. PRESENT VALUE (Discounting Concept)

Present Value is the current value of a future amount, it is calculated using discounting method (discounting is the process of determining the present values of a series of future cash flows). The present value is calculated as follows:

  • Present value of a single cash flow
  • Present value of a series of cash flows
  • Present value of multiple flows.

 

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