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Would you prefer to have Rs.

1crore
now or
Rs.1 crore 10 years from now?

O Of course, we would all prefer the


money now!
O This illustrates that there is an
inherent monetary value attached
to time.
á 
 


O Time value of money means | || 

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O The main reason for the time
preference for money is to be found
in the reinvestment opportunities
for funds which are received early.

O The funds so invested will earn a


rate of return; which would not be
possible if the funds are received at
a later time.
O The time preference for money is,
therefore, expressed generally in
terms of a rate of return or more
popularly as discount rate.
¦
O i i

O uppose Mr.X is given a choice of


receiving Rs.1,000 either now or one
year later.
O His choice would obviously be for the
first alternative as he can deposit the
amount in his saving bank account and
earn a nominal rate of interest, say, five
per cent.

O At the end of the year, the amount will


accumulate to Rs.1,050.
O mn other words, the choice before
Mr.X is between Rs.1050 and
Rs.1000 at the end of the year.

O As a rational person, Mr.X should


be expected prefer the large
amount (Rs.1050)
O Here we say that the time value of
money, that is, the rate of interest is
five percent.

O mt may thus, be see that future cash


flows are less valuable because of
the investment opportunities of the
present cash flows.
Why TVM is to be considered in Finance
Management?

O The finance Manager is required to make


decisions on investment, finance and
dividend keeping in view the objectives of
the company.
£ The investment/financing decisions such as
purchase of fixed assets or procurement of
funds affect the cash flow in different time
period
Eg:- mf a fixed asset is purchased, it will
require cash outflow immediately and cash
inflow will generate over a period of Time.
£ ˜ow, the above inflows and outflows at
different time periods are not comparable
because a rupee received today is not
comparable with a rupee to be received in
future.

£ Hence for financial decisions the finance


manager has to consider the TVM. me, he
should take the decision by making the
cash flows at different periods of time 
   
0ow to make the cash flows at different period of
time a comparable one ?

O The cash flow at different period can


be made comparable by introducing
the interest factor. For this two
techniques are used
  
|
 -compounding
the present money to a future date
using interest factor.
D
 |
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 - iscounting
the future money to present date
using interest factor
O The interest factor is termed as
targeted rate or Hurdle rate or
Opportunity cost of capital or cost of
capital or Time value of money.
Future Value or Compounding
Technique
O Future value is the future value of a
current amount.

O present sums are converted into future


sums«

O Compounding is the process of finding


the future values of cash flows by
applying the concept of compounded
interest
  
  
O imple interest: the practice of
charging an interest rate only to
an initial sum (principal amount).
O Compound interest: the practice
of charging an interest rate to an
initial sum and to any previously
accumulated interest that has not
been withdrawn.
Future Value
mf you invested Rs.2,000 today in an account
6 interest, with interest
that pays 6%
compounded annually, how much will be in the
account at the end of two years if there are no
withdrawals?


6%
Rs.2,000
FV
Future value of a single cash
flow
FV1 = PV (1+i)n
= 2,000 (1.06)2
= $2,247.20

  
   
    
 ! " 
á !  ! # 

FV = PV( FVF)

Where FVF = (1+r)n


$ 

O uppose your father gave you


Rs.100 on your 22nd birthday. You
deposited this amount in a bank at
10% rate of interest for one year .
How much future sum would you
receive after one year?
FV=100(1+0.10)
=110
j    


O Annuity means fixed payment or


receipt each year for a specified
number of years.
O Annuity can be classified into two
(i) Annuity due (ii) Ordinary Annuity or
Annuity
£

|  means fixed payment or
receipt at the beginning of each
year.

£ Ordinary Annuity or Annuity means


the fixed cash flow at the  of
each year
˜ow Future value of an Annuity is
calculated as

x 
 
x   
Where
A- Annuity
r-Time value of money/rate of
interest
n - ˜umber of years
O The formula can be written as

x %x  %
    & 
á '
O This concept is the exact opposite of
that of compounded value.

O in compounding approach, present


sums are converted into future sums«

O mn present value approach we convert


future sums into present sums«
O Present value is the current value
of a future amount.

O The amount to be invested today at


a given interest rate over a
specified period to equal the future
amount.

O Given positive rate of interest, the


present value of future rupees will
always be lower
O mt is or this reason, that the
procedure of finding present values
is commonly called discounting.

O iscounting is determining the


present value of a future amount.
$ 
O u    
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!     "
#$ " | |    |

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% |  |"
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P(1+0.06)=1060
P=1060/1.06
=1000

Thus Rs.1000 would be the required


investment to have Rs.1060 after the
expiry of one year.

The present value of Rs.1060


received one year from now, given
the interest of 6 per cent is Rs.1000
ë
  
 

 (x %

mt can also be written as,


 x %

Where PVF = 1/(1+r)n


O Present value factor is the
multiplier used to calculate at a
specified discount rate the present
value of an amount to be received
in a future period
$ 

O Mr.X wants to find the present value


of Rs.2000 to be received 5 years
from now, assuming 10 per cent
rate of interest.
Present value of a series of cash
flows
O mn financial analysis we can come across
uneven cash flow streams. Eg:- cash
flow associated with investment project.

O mn order to determine the present value


of mixed stream of cash inflows, all that
is required is to determine the present
value of each future payment and then to
aggregate them to find the total present
value of the stream of cash flows.
" !"

PV= C1/(1+r) + C2/ (1+r)2 +«..+ Cn/(1+r)n

where C1, C2««..Cn are cash flows at the end of


year 1,2«««.n

PV=C1(PVF1)+C2(PVF2)+«««..Cn(PVFn
)
Jë
  


The present value of an Annuity is


calculated as

x
 
x   x
Where A- Annuity
r - Time value of money
n - ˜umber of years
OThe formula can be written as

x
 
x



O
These calculations demonstrate that
time literally is money - the value of the
money you have now is not the same as
it will be in the future and vice versa. o,
it is important to know how to calculate
the time value of money so that you can
distinguish between the worth of
investments that offer you returns at
different times.

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