Time Value of Money

INTRODUCTION TO TIME
VALUE OF MONEY
FACULTY: BINISHA NEPAL

1. Time Value of Money
Definition: Money available at the present time is worth more
than the identical sum in the future due to its potential earning
capacity.
Important concept which applies to all areas of Financial
Management
This core principle of finance holds that, provided money can
earn interest, any amount of money is worth more the sooner it
is received.
Helps in determination of your future worth: This calculation
compares the money received in the future to an amount
of money received today, while accounting for time and
interest.
Rational investors prefer to receive money today rather
than the same amount of money in the future because of
money's potential to grow in value over a given period of
time.
For example, money deposited into a savings
account earns a certain interest rate and will be worth
more after a certain period of time.
What would you prefer- receiving Rs. 10,000 now or after
2 years?
2. Time Value of Money as a tool of
Financial Decision Making Process
It provides financial managers with a more accurate
picture of the benefits and returns they will see on
capital projects and investment opportunities.
Financial managers are able to forecast cash flow and
identify potential risks, which influence their
investment decision-making process.
The time value of money can be applied to evaluate a
company’s options for receiving or paying money at
different times.
For example, the time value of money concept may come
into play when deciding whether it is more cost effective to
make a large purchase, such as equipment or electronics,
by paying for it all upfront or using a payment plan.
Businesses may determine it is better to give customers a
discount in order to receive money immediately instead of
allowing them to pay for their product over a period of
time and receive less.
It can also be used when developing new products to
evaluate the rate of return the company can expect when
undertaking new projects.
Future Value: The Concept of
Compounding
Future value is used to find out how much a cash flow
will be worth in the future by factoring interest rates or
capital gains over a number of time periods.
Year after year, the future value will increase as the
interest gained is reinvested. This is known as
compounded interest.
They can use this information to determine whether
or not the projected returns meet their needs.
Present Value: The Concept of
Discounting
Present value is used to determine how much a future
cash flow is worth in the present.
The future cash flow is discounted back to the present
date using the given interest rate.
The present value shows the amount of money that
would have to be invested now in order to receive the
future amount.
This technique is used in many areas of business as a
way to estimate future profits on a deal and determine
if the initial investment is too high.
Determination of Future Value: Single
Cash Flow
Future Value for a single cash flow in the entire period:
Formula: FVn= PV (1+r)^n
Question: Cyndria deposits $1000 today in her savings
account. If the accountholders are entitled to receive
10% interest per annum, how much will she receive
in 3 years time?
Determination of Future Value: Multiple
Cash Flows- Annuity
Annuity: Identical amount received at an identical
interval for a certain period with the first cash flow
received one period from today
Determination of Present Value: Single
Cash Flow
Present Value for a single cash flow in the entire period:
Example: Liam purchases a contract from an insurance

company. The contract promises to pay $600,000 after 8
years with a 5% discount rate. What amount of money
should Liam most likely invest?
Determination of Present Value: Multiple
Cash Flows- Annuity
Determination of Present Value: Multiple
Cash Flows- Perpetuity
Perpetuity: Set of never ending sequential cash flows

with the first cash flow occurring one period from today
Formula: PV= A/r
Example: Simple example to understand the formula:
You invest $100 and get 5% for ever. What is the cash
flow?
Determination of PV and FV: Series of
Unequal Cash Flows
Andy makes an investment with the expected cash flow
shown in the table below. Assuming a discount rate of
9% what is the present value of this investment?
Time Period Cash Flow($)
1 50
2 100
3 150
4 200
5 250 Answer: 550
Interest Rates: Interpretation
Interest rates can be interpreted as:
1. Discount Rates: The rate at which the future values
and discounted to get the present value
2. Required Rate of Return: Minimum return required
by an investor to make an investment
3. Opportunity Cost: The cost/ rate of return of next
best alternative
Interest Rate: Investor’s Perspective
-The End-
Reference: www.irfanullah.co; Investopedia; https://onlinemasters.ohio.edu/time-value-of-money-principles-and-

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INTRODUCTION TO TIME

FACULTY: BINISHA NEPAL

Example: Liam purchases a contract from an insurance

Perpetuity: Set of never ending sequential cash flows

Reference: www.irfanullah.co; Investopedia; https://onlinemasters.ohio.edu/time-value-of-money-principles-and-

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