Published by: Nuru
Published date: 27 Feb 2022
Concept of Time Value of Money:
According to the time value of money concept, a rupee in hand today is worth more than a rupee promised at some time in the future. In essence, a rupee earned today is way more valuable than a rupee earned in the future. So, the financial managers must have a clear understanding of the time value of money.
The concept of Time Value of Money refers to the concept that the present value of certain money is greater than the future value of the same certain money.
The time value of money deals with the economic significance of cash flows.
Time Line:
Time line is drawn to explain clearly the time value of money problems. Sometimes it is required to find PV or FV or time period or rate of interest.
To understand the time value of the money concept, we need to understand the time line accurately. Time line has four variables :
Present value (PV):
It is the value today. The present value at Rs. 1 at selected interests for different periods or years can be seen as PVIF (Present value interest factor) values as provided in the table of PVIF. Similarly, the present value of an annuity, PVIFA (present value interest factor annuity) values may be seen from the table of PVIFA.
Future value (PV):
It is the value at a future date. The future value at Rs. 1 at selected interests for different periods or years can be seen as FVIF (Future value interest factor) values as provided in the table of FVIF. Similarly, the future value of an annuity, FVIFA (future value interest factor annuity) values may be seen from the table of FVIFA.
Rate of interest (i):
The rate is denoted by i or r.
Number of time periods:
The number of periods between the Present value and future value is represented by 't'. Time '0' is today; time '1' is the end of period 1 or the beginning of period 2, and so on.
If the project receives the fixed amount of money at the end of every year or period with a certain rate of interest, for a certain period of time, it is called an ordinary annuity. It is the case of equal cash flows at the end of the period.