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Time Value of Money

The document discusses the time value of money and methods for calculating present and future values. It covers four key sections: future value of a single amount, future value of an annuity, present value of a single amount, and present value of an annuity. Compounding and discounting are the two main methods used to adjust cash flows for the time value of money. Compounding calculates future values, while discounting calculates present values using an interest rate. Examples are provided to illustrate future and present value calculations for both single amounts and annuities.

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Simran
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175 views16 pages

Time Value of Money

The document discusses the time value of money and methods for calculating present and future values. It covers four key sections: future value of a single amount, future value of an annuity, present value of a single amount, and present value of an annuity. Compounding and discounting are the two main methods used to adjust cash flows for the time value of money. Compounding calculates future values, while discounting calculates present values using an interest rate. Examples are provided to illustrate future and present value calculations for both single amounts and annuities.

Uploaded by

Simran
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
You are on page 1/ 16

THE TIME VALUE OF MONEY

LEARNING OBJECTIVES
2

 Understand what gives money its time value.


 Explain the methods of calculating present and
future values.
 Highlight the use of present value technique
(discounting) in financial decisions.
Introduction
3

 Money has time value. A rupee today is more valuable than a


rupee a year hence, there are several reasons:
 Individuals prefer current consumption to future consumption.
 Capital can be employed productively to generate positive
returns. An investment of one rupee today would grow to
(1+r) a year hence.
 In an inflationary period a rupee today represents a greater
real purchasing power than a rupee a year hence.
Time Value of Money
4

 It is divided into four sections:


 Future Value of a single amount.
 Future Value of an annuity.
 Present Value of a single amount.
 Present Value of an annuity.
Concept of Future Value & Present Value
5

 Would an investor want Rs. 100 today or after one year?


 Cash flows occurring in different time periods are not comparable.
 It is necessary to adjust cash flows for their differences in timing and risk.
 Example : If preference rate =10 percent
 An investor can invest if Rs. 100 if he is offered Rs 110 after one year.
 Rs 110 is the future value of Rs 100 today at 10% interest rate.
 Also, Rs 100 today is the present value of Rs 110 after a year at 10%
interest rate.
 If the investor gets less than Rs. 110 then he will not invest. Anything
above Rs. 110 is favourable.
Time Value Adjustment
6

 Two most common methods of adjusting cash


flows for time value of money:
 Compounding—the process of calculating future values
of cash flows and
 Discounting—the process of calculating present values of
cash flows.
Future Value
7

 Compounding is the process of finding the future values of


cash flows by applying the concept of compound interest.
 Compound interest is the interest that is received on the
original amount (principal) as well as on any interest earned
but not withdrawn during earlier periods.
 Simple interest is the interest that is calculated only on the
original amount (principal), and thus, no compounding of
interest takes place.
Future Value of a Single Amount
8
Future Value: Example
9
Future Value of an Annuity
10
Future Value of an Annuity: Example
11
Present Value
12

 Present value of a future cash flow (inflow or


outflow) is the amount of current cash that is of
equivalent value to the decision-maker.
 Discounting is the process of determining present
value of a series of future cash flows.
 The interest rate used for discounting cash flows is
also called the discount rate.
Present Value of a Single Cash Flow
13
Example
14
Present Value of an Annuity
15
Example
16

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