Fm-Time Value of Money

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Management Science-II

Prof. R.Madumathi

MODULE 2 Finance – An Introduction
The functions of finance in an organization is interlinked with other managerial responsibilities and in many instances, the finance manager could also done the role of a managing director. For the smooth functioning as well as to achieve excellence, organizations have to concentrate on the financial impact of a decision and its consequences. This also helps the organization to aim at a desired competency level against its competitors.

Basic Concept In Finance
• In organizations, flow of money occurs at various points of time. In order to evaluate the worth of money, the financial managers need to look at it from a common platform, namely one time duration. This common platform enables a meaningful comparison of money over different time periods.



An important principle in financial management is that the value of money depends on when the cash flow occurs – which implies Rs.100 now is worth more than Rs.100 at some future time.

Indian Institute of Technology Madras

Management Science-II

Prof. R.Madumathi

Time Value Of Money

Time Value Of Money
The Time-Value Of Money
Money like any other desirable commodity has a price. If you own money, you can, 'rent' it to someone else, say a banker, who can use it to earn income. This 'rent' is usually in the form of interest. The investor's return, which reflects the time-value of money, therefore indicates that there are investment opportunities available in the market. The return indicates that there is a – risk-free rate of return rewarding investors for forgoing immediate consumption – compensation for risk and loss of purchasing power.

Indian Institute of Technology Madras

Management Science-II

Prof. R.Madumathi

Time Value Of Money
• Risk: An amount of Rs.100 now is certain, whereas Rs.100 receivable next year is less certain. This 'uncertainty' principle affects many aspects of financial management and is termed as risk value of money.



Inflation: Under inflationary conditions, the value of money, expressed in terms of its purchasing power over goods and services, declines. Hence Rs.100 possessed now is not equivalent to Rs.100 to be received in the future.



Personal consumption preference: Most of us have a strong preference for immediate rather than delayed consumption. As a result we tend to value the Rs.100 to be received now more than Rs.100 to be received latter.

Future Value Vs. Present Value
Future value (FV) and present value (PV) adjust all cash flows to a common time. This is relevant when we want to compare the cash flows occurring at different periods of time. Either in terms of projects, performance or turnover, the cash flows accrue to the company at different stages. The evaluation of all these cash flows are true when they are all brought to the same base period.

Computing Present Value
In financial parlance, a value of currency is not kept idle. The amount, if invested would certainly bring additional returns in the future. This future expectation from the present investment is termed as the future value.

Indian Institute of Technology Madras

Management Science-II

Prof. R.Madumathi

Let us assume x amount is invested now and the investor expects r% to accrue on the investment one year ahead. This is translated into present and future values as follows: PV = Rs. x FV = Rs. x + (r * x)

Computing Future Value – Example
Let us assume Rs.1,000 is invested now and the investor expects 5% to accrue on this investment one year ahead. This is translated into present and future values as follows: PV = Rs.1,000 FV = Rs.1,000 + (.05 * 1,000) = Rs.1,050.

Computing Future Value
This can be restated as FV = PV * (1+r)

This relationship leads to the following concept of discounting the future value to arrive at the present value i.e., PV = FV / (1 + r)

This is the formula for equating the future value that...
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