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Time Value of Money

The document discusses the time value of money, which refers to the concept that money received today is worth more than the same amount in the future. It introduces tools for financial analysis like future value, present value, and discounting cash flows that allow managers to compare the value of cash inflows and outflows that occur at different points in time. It provides examples of how to apply these concepts to evaluate investments that involve spending money up front in exchange for returns over several years in the future.

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Yeji
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38 views

Time Value of Money

The document discusses the time value of money, which refers to the concept that money received today is worth more than the same amount in the future. It introduces tools for financial analysis like future value, present value, and discounting cash flows that allow managers to compare the value of cash inflows and outflows that occur at different points in time. It provides examples of how to apply these concepts to evaluate investments that involve spending money up front in exchange for returns over several years in the future.

Uploaded by

Yeji
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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TIME

VALUE

OF

MONEY
THE ROLE OF TIME VALUE IN FINANCE

The time value of money refers to the observation that it is


better to receive money sooner than later. Money that you
have in hand today can be invested and earn a positive rate
of return, producing more money tomorrow. For that
reason,

“A dollar today is worth more that a dollar in the


future.”
In business, managers, constantly face trade-offs in
situations where actions that require outflows of cash
today may produce inflows of cash later.

Because the cash in the future is worth less than the cash
that firms spend up front, managers need a set of tools to
help them compare cash inflows and outflows that at
different times.
1. FUTURE VALUE

2. PRESENT VALUE

A. SINGLE AMOUNT
B. ANNUITY
C. MIXED STREAMS
1. ORDINARY ANNUITY
2. ANNUITY DUE
1.FUTURE VALUE – the value at a given future date of an
amount place on deposit today and earning interest at a
specified rate. Found by applying compound interest over a
specified period of time.

Compound interest - interest that is earned on agiven


deposit and has become part of the principal at the end of
a specified period.

Principal - is the amount of money on which interest is


paid.

Compounding – is the process of finding the future value.


2. Present Value – the current dollar value of a future
amount – the amount of money that would have to be
invested today at a given interest rate over a specified period
to equal the future amount.

discounting cash flows – the process of finding present


value; the inverse of compounding interest.
Future Value Versus Present Value

Suppose a firm has an opportunity to 15,000 today on some


investment that will produce 17,000 spread over the next five
years as follows:

Year 1 3,000
Year 2 5,000
Year 3 4,000
Year 4 3,000
Year 5 2,000

Is this a wise investment?


It might seem that the obvious answer is YES because the firm
spends 15,000 and receives 17,000. Remember, though,
that the value of dollars the firm receives in the future is less
that the value of the dollars that they spend today. Therefore,
it is not clear whether the 17,000 inflows are enough to
justify the investment.

Time value of money analysis helps managers answer questions


like these. The basic idea of managers need a way to
compare cash today versus cash in the future.
There are two ways of doing this.

1. One way is to ask the question,


What amount of money is the future is equivalent to
15,000 today? In other words, what is the future value of
15,0000?

2. The other approach asks,


What amount today is equivalent to 17,000 paid out
over the next 5 years as outlined above? In other words,
what is the present value of the stream of cash flows
coming in the next 5 years?
TIME LINE

A horizontal line on which time zero appears at the leftmost


end and future periods are marked from left to right; can be
used to depict investment cash flows.

-15,000 3,000 5,000 4,000 3,000 2,oo


1___________1__________1__________1___________1__________1_____
0 1 2 3 4 5
end of year

The cash flows occurring at time zero (today); the negative


values are outflows and the positive values are inflows.
COMPUTATIONAL TOOLS

Financial Calculators

Electronic Spreadsheets
BASIC PATTERNS OF CASH FLOW

1. Single amount – a lump sum amount either


currently held or expected at some future date.
Examples include 1,000 today and 6.50 to be
received at the end of 10 years.
BASIC PATTERNS (con’t)

2. Annuity – a level periodic stream of cash flow.


Examples include either paying out or
receiving 800 at the end of each of the next 7 years.

3. Mixed stream – a stream of cash flow that


is not an annuity; a stream of unequal periodic
cash flows that reflect no particular pattern.
Example of Mixed Cash Flow Stream

End of year A B
1 100 -0
2 800 100
3 1,200 80
4 1,200 -60
5 1,400
6 300

Note that neither cash flow stream has equal, periodic cash
flows and that A is a 6-year mixed stream and B is a 4-
year mixed stream.
END

OF

PRESENTATION

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