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Time Value of Money: Presented By: Diptendu Basu EXECUTIVE MBA (2012-2014) PRN NO: 001
Time Value of Money: Presented By: Diptendu Basu EXECUTIVE MBA (2012-2014) PRN NO: 001
INTRODUCTION
Money has time value. A rupee today is more valuable than a
year hence. It is on this concept the time value of money is based. The recognition of the time value of money and risk is extremely vital in financial decision making. Most financial decisions such as the purchase of assets or procurement of funds, affect the firms cash flows in different time periods. Cash flows become logically comparable when they are appropriately adjusted for their differences in timing and risk. The recognition of the time value of money and risk is extremely vital in financial decision-making. Thus, we conclude that time value of money is central to the concept of finance. It recognizes that the value of money is different at different points of time.
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Inflation:
In an inflationary economy, the money received today, has more purchasing power than the money to be received in future. In other words, a rupee today represents a greater real purchasing power than a rupee a year hence.
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Future value is the cash value of an investment at some time in the future. It is tomorrows value of todays money compounded at TVM. It is same thing as the amount that we learnt in the compounded interest formula at school.
FORMULA - 1 FV = PV X (1+TVM)n FV = TODAYS INVESTMENT X FVF FV FUTURE VALUE PV PRESENT VALUE
WHERE INVEST FOR n YEARS AT r % OUR INVESTMENT WILL GROW TO (1+r)n. (1+r)n IS CALLED FUTURE VALUE FACTOR.
Future value is tomorrows value of today's money compounded at time value of money. Twist that around and we can say present value is today's value of tomorrows money discounted at the time value of money. In others words future value and present value are related to each other in fact they are reciprocal to each other. FV = Today's investment x FVF We know that today's investment is called Present Value Hence FV = Present Value x FVF Or FV x 1/ FVF = Present Value 1/FVF is called the present value factor Hence PV = Tomorrows Value x PVF Or PV = Single sum x PVF Present value factor also called the discount factor. It is also the Time Value of Money
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In this case we simply have to compute the future value of cash flow as at specified date and then add them. Step 1 : Decide the future date. Compute future value of each cash flow. Step 2: Aggregate.
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So how does one can calculate the present value of an uneven cash flow stream? While there are several methods we can do as following: Step 1: Compute the present value of each of the cash flow separately. Step 2: Aggregate the present values.
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Step 1 : Compute Future Value Annuity Factor(FVAF) using the formula : FVAF = [ FVF-1]/R or by referring to the FVAF table. Step 2: FVA = Annuity x FVAF
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Step 1: Compute PVAF using the formula : PVAF = [1-PVF]/R or by referring PVF table Step 2: Present value of annuity = Annuity x PVAF
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Perpetuity is a special kind of annuity where the annual receipt or payment takes place forever. Since the payment is for ever we cant compute a future value. However we can compute a future value of the perpetuity. We would like to do so because we would like to compare this with alternative options.
PV of perpetuity = Perpetuity/ Time value of money
ISSUE 10 . COMPOUNDING AT FASTER FREQUENCY(MULTIPLE COMPOUNDING PERIOD) Interest can be compounded monthly, quarterly and half-yearly. If compounding is quarterly, annual interest rate is to be divided by 4 and the number of years is to be multiplied by 4. Similarly, if monthly compounding is to be made, annual interest rate is to be divided by 12 and number of years is to be multiplied by 12. The formula to calculate the compound value is
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where, FVn = Future value after n years PV = Cash flow today r = Interest rate per annum m = Number of times compounding is done during a year n = Number of years for which compounding is done.
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THANK YOU
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