Explain Time Value of Money Concept

Time Value of Money (TVM)

          Time Value of Money is one of the most important concept in financial management. It helps us to make sound decisions on investments, leasing, mortgage and decisions related to financial management.  This concept is based mainly on present value of money and future value of money mainly.

Meaning of Time Value of Money

          Time Value of Money means that today’s one rupee will not be one rupee in the future. This means that in future the purchasing power of one rupee will come down when compared to present. The depression in value of money is because of various factors which are influencing it such as inflation rate, GDP, interest and many other factors. To understand the concept of TVM we need to understand present value and future value of money to understand TVM in detail.

§  Present Value of Money(PV):

Present Value is the amount today which is equivalent to certain value in future at an appropriate discounted interest rate. Since money has time value, the longer the waiting period for money the lesser the value of the money we receive it. The difference that lies is the compounding periods involved and the interest rate of discount. We can express the present value in numerical terms as

PV = FV {1/ (1+i)ⁿ }

§  Future Value of Money(FV):

        Future Value is the amount which is invested today to grow at a certain date in future. Since money has time value, it is expected that the amount on maturity date will be greater than the present value of the money. The increase in money value will be the interest rate and the compounding periods involved. It can be expressed in mathematical terms as

FV=PV (1+i)ⁿ  

§  Annuity:

        An annuity is a series of equal payments or receipts that occur at evenly spaced intervals. Leases and rental payments are examples.

·     Present Value of Ordinary Annuity(PVoa):

          The present value of ordinary annuity is the value of a stream of promised future value which has been discounted to a single equivalent value of today. It is very useful in comparing two different cash flows that differ in same way. PVoa can also be said that specific amount invested at a specific interest rate and then withdraw of equal amount in equal internals such that the accumulated interest and principal gets exhausted at the end of annuity. It can be mathematical expressed as

PVoa = PMT {[ 1- (1 / (1 + i)ⁿ)] / i}

·     Future Value of an Ordinary Annuity(FVoa):

          The Future Value of Ordinary Annuity is the value of expected series of cash flow which are promised future payments which are expected to grow at a given compound interest rate in a specific period. It can be calculated and expressed in mathematical terms as

FVoa= PMT { [(1+i)ⁿ -1]/i}