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Time Value of Money

1. Time Value of Money (TVM) refers to the concept that the value of money changes over time due to interest, inflation, or other factors. There are two basic concepts in TVM: future value and present value. 2. Future value is the value of an amount of money in the future, taking compound interest into account. Present value is the current worth of a future amount, discounted back to the present time. 3. TVM principles are used in many financial decisions, including investment decisions, lending decisions, project selection and life cycle cost calculations. TVM calculations use factors like interest rates, time periods, and frequency of compounding to determine future and present values.

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Chitrakshi Kumar
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57 views

Time Value of Money

1. Time Value of Money (TVM) refers to the concept that the value of money changes over time due to interest, inflation, or other factors. There are two basic concepts in TVM: future value and present value. 2. Future value is the value of an amount of money in the future, taking compound interest into account. Present value is the current worth of a future amount, discounted back to the present time. 3. TVM principles are used in many financial decisions, including investment decisions, lending decisions, project selection and life cycle cost calculations. TVM calculations use factors like interest rates, time periods, and frequency of compounding to determine future and present values.

Uploaded by

Chitrakshi Kumar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Time Value of Money (TVM)

1. Value of Money a function of Time


Money received today has different value at future point of time. Similarly money proposed
to be received at a future time has different value at present time. The rate of Compound
Interest' is used to express the Time Value of money.

2. Two basic concepts involved in TVM :


2.1 Future Value (FV) :
Future value is the value at some future time of a present single amount of money or a series
of amounts (cash flow) determined based on a given interest rate (Principle of
Compounding)
2.2 Present Value (PV):
Present value is the current value of a future single amount of money or a series of amounts

PRESENT VALUE INTEREST FACTOR(PVIFin)

FUTURE VALUE INTEREST FACTOR(FVIFin)

(cash flow) determined based on a given interest rate (Principle of discounting).

CONCEPT OF FUTURE VALUE(COMPOUNDING)

4.00

i = 15%
3.50

Compounding for future


value at 15% per year

3.00
2.50
i = 10%
2.00
i = 5%

1.50
0
1

0.90

10 11 12 13 14 15

PERIOD(n)(Years)

0.80
0.70

i = 5%

0.60
0.50
i = 10%

0.40
0.30
0.20

Discounting for
present value at
15% per year

i = 15%

0.10
0.00

CONCEPT OF PRESENT VALUE(DISCOUNTING)

-1-

Years

3. Applications of Time Value of Money


a) All Financial decisions of firms are based on TVM.
b) Individual investment decisions (e.g. Retirement Plans)
c) Lending decisions (e.g. Housing loans repayments spread over years)
d) Selection of alternatives between projects whose initial investment and period of yield
differ where common basis are to be arrived
e) Life cycle cost calculations (V.E. applications) (Machineries, Systems etc.)

4.1 Future Value (Compound Value) of a single present amount


FVn = PV(1+i)n ..equation (1)
FVn = PV(FVIFin)
FVn

= Future Value after n years

PV

= Present Value

FVIFin = Future Value factor at i% for n periods


It is assumed that compounding done once in a year
i = 12%

7
i = 10%
6
5
4
FVIFin

i = 6%
3
2
i = 0%

1
0
2

10

12

14

16

18

20

Years

Approximate doubling period in years = 72


i
Refer Standard Tables for F V I F for various combinations of period ( n ) and interest rate (i).

-2-

4.2 Future Value of a Single Present Amount

if compounding done more number of

times in a year
If m is number of times compounding done in a year,
FVn= PV(1+i/m)m x n
e.g. If compounding done semi-annually
FVn = PV(1+i/2)2n

Effective Rate of Interest (i)


Effective rate of interest is the annually compounded rate of interest which is equivalent to an
annual interest rate compounded more than once in a year
i 0 = (1+i/m)m 1
e.g. If 8% is the nominal annual interest rate and compounding done quarterly
(m=4)
i 0 = (1+0.08/4)4 1
= 0.0824
= 8.24% >8%

i 0 = 12.68%(monthly compounded)
i 0 = 12.63%(half yearly)
i 0 = 12.74%(daily compounded)
To compare alternate investments having different compounding periods it is necessary to
calculate the effective annual interest rates.

5. Present Value(discounted value) of a single future amount


From equation(1)
FVn = PV(1+i)n
PV = FVn[1/(1+i)n]
PV = FVn(PVFin)
PV

= Present Value

FVn

= Future amount after n years

PVIFin = Present Value interest factor with interest rate i for n periods

-3-

PVIFin

1.25
1.00

i = 0%

0.75

i = 6%

0.50

i = 10%

0.25

i = 14%

0.00
2

10

Period

Present Value of Rs. 1 proposed to be received after 5 years at a discounting rate of 10% is
about 50 paise.

-4-

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