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    The Significance of Time Value of Money - : Investment Decision

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    Ngawang Lhamo
    The time value of money is a fundamental concept in finance that holds that money available at present is worth more than the same amount in the future due to its potential earning capacity. The concept of time value of money significantly contributes to financial decision making by allowing investors to compare cash flows that occur at different points in time and evaluate long term investment projects. It is useful for both investment decisions, such as evaluating whether adding to capital assets will increase future revenues, and financing decisions, like comparing the costs of different sources of financing by calculating present values. Additionally, the time value of money concept is applied in operational decisions regarding credit policies and managing cash collection.

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    The Significance of Time Value of Money - : Investment Decision

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    Ngawang Lhamo
    79 views2 pages
    The time value of money is a fundamental concept in finance that holds that money available at present is worth more than the same amount in the future due to its potential earning capacity. The concept of time value of money significantly contributes to financial decision making by allowing investors to compare cash flows that occur at different points in time and evaluate long term investment projects. It is useful for both investment decisions, such as evaluating whether adding to capital assets will increase future revenues, and financing decisions, like comparing the costs of different sources of financing by calculating present values. Additionally, the time value of money concept is applied in operational decisions regarding credit policies and managing cash collection.

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    The time value of money is a fundamental concept in finance that holds that money available at present is worth more than the same amount in the future due to its potential earning capacity. The concept of time value of money significantly contributes to financial decision making by allowing investors to compare cash flows that occur at different points in time and evaluate long term investment projects. It is useful for both investment decisions, such as evaluating whether adding to capital assets will increase future revenues, and financing decisions, like comparing the costs of different sources of financing by calculating present values. Additionally, the time value of money concept is applied in operational decisions regarding credit policies and managing cash collection.

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    79 views2 pages

    The Significance of Time Value of Money - : Investment Decision

    Uploaded by

    Ngawang Lhamo
    The time value of money is a fundamental concept in finance that holds that money available at present is worth more than the same amount in the future due to its potential earning capacity. The concept of time value of money significantly contributes to financial decision making by allowing investors to compare cash flows that occur at different points in time and evaluate long term investment projects. It is useful for both investment decisions, such as evaluating whether adding to capital assets will increase future revenues, and financing decisions, like comparing the costs of different sources of financing by calculating present values. Additionally, the time value of money concept is applied in operational decisions regarding credit policies and managing cash collection.

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    The significance of Time Value of Money –

    The time value of money is the idea that money available at the present time is
    worth more than the same amount in the future due to its potential earning
    capacity. Time value of money is a widely used concept in the literature of
    finance. Financial decision models based on finance theories basically deal with
    the maximization of the economic welfare of shareholders. A fundamental idea in
    finance that money that one has now is worth more than money one will receive
    in the future.

    The concept of time value of money contributes to this aspect to a greater extent.
    The significance of the concept of time value of money could be stated as below:

    Investment Decision

    The investment decision is concerned with the allocation of capital into long-term
    investment projects. The cash flow from long-term investment occurs at a
    different point in time in the future. In other words, investment decisions are
    concerned with the question of whether adding to capital assets today will
    increase the revenues of tomorrow to cover costs. They are not comparable to
    each other and against the cost of the project spent at present. To make them
    comparable, the future cash flows are discounted back to present value. As such
    investment decisions are concerned with the choice of acquiring real assets over
    the time period in a productive process.

    The concept of time value of money is useful to securities investors. They use
    valuation models while making an investment in securities such as stock and
    bonds. These security valuation models consider the time value of cash flows
    from securities.

    Financing Decision

    Financing decision is concerned with designing optimum capital structure and


    raising funds from the least cost sources. The concept of time value of money is
    equally useful in financing decision, especially when we deal with comparing the
    cost of different sources of financing. It is concerned with the borrowing and
    allocation of funds required for the investment decisions. The effective rate of
    interest of each source of financing is calculated based on the time value of
    money concept. Similarly, in leasing versus buying decision, we calculate the
    present value of the cost of leasing and the cost of buying. The present value of
    costs of two alternatives is compared against each other to decide on an
    appropriate source of financing. The objective of financial decision is to maintain
    an optimum capital structure, i.e. a proper mix of debt and equity, to ensure the
    trade-off between the risk and return to the shareholders.

    Besides, the concept of time value of money is also used in evaluating proposed
    credit policies and the firm’s efficiency in managing cash collection under current
    assets management.

    Significance of Time Value of Money It is mostly used concept in Finance world; based on this, decisions
    are made to maximize return on investments. It helps shareholders to invest their fund wisely. Its
    concept contributes to this aspect to much extent. Its significance are as follows: 1. Investment Decision
    is decision to make investment of funds for long term purpose. TVM help us to identify long term cash
    flow statements which will occur at different point of time. So, if investor have two projects to invest its
    money in, those two projects can be compared with this technique even if their cash flow statement
    time period doesn’t matches with each other by providing present value of their future cash flow. Its
    concept is mostly used in equity or debt securities investment by using valuation models while doing
    investments. 2. Financing Decision is decision to make to optimize capital structure of the organization.
    Raising fund for equity, debt or from any other source. TVM helps in this decision by comparing cost to
    company through usage of effective rate of interest of each source of finance. And then present value of
    costs of two alternatives is compared against each other to decide on appropriate source of financing. 3.
    Operational Decision: This concept is also used in evaluating creditor cycle and debtors’ cycle in
    managing cash collection under current assets management.

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