TIME VALUE OF MONEY

TIME VALUE OF MONEY

Basic problem:
-How to determine value today of cash flows that are expected in the
future?
Time value of money refers to the fact that a dollar in hand today is
worth more than a dollar promised at some time in the future.
Which would you rather have – Rs 1000 today or Rs 1000 in 5 years?
Obviously , Rs 1000 today.
Money received sooner rather than later allows one to use the funds
for investment or consumption purposes. This concept is referred to
as the” TIME VALUE OF MONEY”
TIME allows one the opportunity to postpone consumption and earn
INTEREST.
 FUTURE VALUE AND COMPOUNDING

Future value refers to the amount of money and investment will grow
to over some length of time at some given interest rate.
To determine the future value of single cash flows, we need:
present value of cash flow(PV)
interest rate (r), and
time period(n)
FVn = PV0 × (1 + r)n
Future Value Interest factor at ‘r’ rate of interest for ‘n’ time
periods.
Examples on consumption of Future Value of a single cash
flow
 FUTURE VALUE (GRAPHIC)

If you invested Rs 2,000 today in an account that pays 6%

interest, with interest compounded annually, how much
will be in the account at the end of 2 years if there are no
withdrawals?

 0 1 2
6%
Rs2,000

FV
 FUTURE VALUE (FORMULA)

FV1 = PV (1+r)n
= Rs 2,000 (1.06)2
= Rs 2,247.20
PRESENT VALUE AND DISCOUNTING
The current value of future cash flow discounted at
the appropriate discount rate over some length of
time period.
Discounting is the process of translating a future
value or set of future cash flow into a present value.
To compute present value of a single cash flow, we
need:
PV0 = FVn / (1 + r)n
Examples
 EXAMPLES
 Assume that you nerved 10 years from now. How much you deposit
today in an account that pays 6% interest, so that you reach your goal
of Rs 4000?

0 5 10
6%

Rs 4,000
PV0
 PRESENT VALUE
(FORMULA)
PV0 = FV / (1+r)10
= Rs 4,000 / (1.06)10
= Rs 2,233.58
 PRESENT VALUE VERSUS
FUTURE VALUE
Present value factors are reciprocals of future value
factors.
Interest rate and future value are positively related.
Interest rate and present value are negatively related.
Time period and future value are positively related.
Time period and present value are negatively related.
 DETERMINING THE
INTEREST RATE (r)
At what rate of interest should we invest our money
today to get a desired amount of money after a certain
number of years?
Essentially, we are trying to determine the interest rate
given present value (PV), future value(FV), and time
period (n)
The rate which money can be doubled/ tripled.
 DETERMINING THE TIME PERIOD
(n)
For how long should we invest money today to get a
desired amount of money in future at a given rate of
interest.
Determining the time period (n) for which a current
amount (PV) needs to be invested to get a certain future
value (FV) given a rate of interest (r).
The time period needed to doubled/triple our current
investment.
THANK YOU