03

Time Value of Money

Ms. Asini Nimaya Ms. G L Aloka
asinin@sltc.ac.lk lakmaleea@sltc.ac.lk
071-9588515 070-6230109
Which would you prefer, Rs.10,000 today
or Rs. 10,000 two years from now?
Money has a time value because:

1. Risk and Uncertainty

Future is always uncertain and risky. Outflow of cash is in our control as payments to parties
are made by us. There is no certainty for future cash inflows.
Cash inflows is dependent out on our Debtors, Bank etc.
As an individual or firm is not certain about future cash receipts, it prefers receiving cash
now.
2. 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.
Money has a time value because:

3. Consumption
Individuals generally prefer current consumption to future consumption.

4. Investment opportunities
An investor can profitably employ a rupee received today, to give
him a higher value to be received tomorrow or after a certain period of time.
Thus, the fundamental principle behind the concept of time value of money
is that, a sum of money received today, is worth more than if the same is
received after a certain period of time.

Hence, for deferment of your consumption/Investment or for risk/inflation

you require
compensation (Interest) in future. Which means that you expect more than
what you want today if you are to receive it at a later date.
 Simple Interest
Simple interest is interest that is paid (earned) on only the original amount, or principal,
borrowed (lent).

The rupee amount of simple interest is a function of three variables:

i. The original amount borrowed (lent), or principal;
ii. The interest rate per time period
iii. The number of time periods for which the principal is borrowed (lent).

Future Value (simple interest) = P + PRT

(Key: P – principal; R – annual interest rate; T – period in years)

Example 01– Simple Interest

If you invest RS. 1,000/= in a bank account which gives you 10% simple
annual interest, determine the value of your investment after 5 year
Activity 01 – Simple Interest

1. Saman has 2 investment options to invest his Rs.25,000 for 5 years.

Option 1 – he can lend this amount to Nimal. Nimal will pay back Rs.32,000 after 5
years

Option 2 – he can deposit this amount at a 12% interest rate (simple interest) in a fixed
deposit.

According to your calculations which option is the best?

Thank you!