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Time Value of Money

The document discusses the time value of money, which refers to the principle that the value of money decreases over time due to investment opportunities, inflation, risk, and personal consumption preferences. It describes two techniques for calculating the time value of money: compounding and discounting. The compounding technique uses a formula to calculate the future value of an amount by compounding interest over time, while the discounting technique calculates the present value of a future amount. Tables can also be used to lookup compound and present values for different interest rates and time periods.

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Rey Cereno
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154 views

Time Value of Money

The document discusses the time value of money, which refers to the principle that the value of money decreases over time due to investment opportunities, inflation, risk, and personal consumption preferences. It describes two techniques for calculating the time value of money: compounding and discounting. The compounding technique uses a formula to calculate the future value of an amount by compounding interest over time, while the discounting technique calculates the present value of a future amount. Tables can also be used to lookup compound and present values for different interest rates and time periods.

Uploaded by

Rey Cereno
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Time Value of Money

 An important principle in finance is that the value of money is time


dependent.
 The value of a unit of money is different in different time periods.
 The value of a sum of money received today is more than its value received
after some time.
 Conversely, a sum of money received in future is less valuable than it is
today.
 The time value of money is also referred as time preference for money.
Reasons for Time Value of Money

 Investment Opportunities: Money has the potential to grow over a period of


time because it can be invested somewhere. For example, if Rs. 1000 can be
invested in a fixed deposit for one year at 7% p.a., the money will grow to Rs,
Rs. 1070 at the end of one year. Therefore, given the choice of Rs. 1000 now
or the same amount in one year’s time, it is always preferable to take Rs.
1000 now.
 Inflation: Inflation is the fall in the purchasing power of money. It makes
money cheaper and the goods and services costlier. Suppose you can buy 1 kg
of rice with Rs. 50 today. If the inflation rate is 10%, You need Rs. 55 to buy 1
kg of rice a year from now.
Reasons for Time Value of Money

 Risk: Money received now is certain, whereas money tomorrow is less certain.
This ’bird in the hand’ principle is extremely important in investment
appraisals.
 Personal consumption preference: Many people have a strong preference for
immediate rather than delayed consumption. For a hungry man, promise of a
meals next month means nothing.
Techniques

 Two methods to calculate the time value of money


 Compounding Technique
 Discounting Technique
Compounding Technique

 In compounding technique, interest is added (compounded) to the initial


deposit (principal) and becomes part of the principal at the end of each
compounding period.
 Annual compounding, semi-annual compounding, quarterly compounding,
monthly compounding etc.
Compounding Technique Formula

 A = P (1+i)n
 In which
 A = Amount at the end of the period
 P= Principal at the beginning of the period
 i = Rate of interest
 N= number of years
Compounding Technique Formula

 For semi-annual compounding, the formula is:


A = P (1+i/2)n x2
 For quarterly compounding, the formula is:
A = P (1+i/4)n x4
 Alternatively, for compounding more than once a year, the formula can be
expressed as:
A = P (1+i/m)n xm
Where m = number of times per year compounding is made.
Compound value table

 file:///C:/Users/JM/Documents/Financial%20management/compound%20valu
e%20table.webp
Present value table

 APPENDIX B_ PRESENT VALUE AND FUTURE VALUE TABLES - Taxation for Decisi
on Makers, 2012 Edition [Book].html

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