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    ACM CH 2

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    Accounting Lecture Course for Msc in Accounting and Finance chapter 2

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    ACM CH 2

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    tilahunthm
    24 views3 pages
    Accounting Lecture Course for Msc in Accounting and Finance chapter 2

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    ACM Ch 2

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    Accounting Lecture Course for Msc in Accounting and Finance chapter 2

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    Download as rtf, pdf, or txt
    24 views3 pages

    ACM CH 2

    Uploaded by

    tilahunthm
    Accounting Lecture Course for Msc in Accounting and Finance chapter 2

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    © All Rights Reserved
    Download as RTF, PDF, TXT or read online from Scribd
    Download as rtf, pdf, or txt
    of 3

    Time value of money

    CONCEPT OF TIME VALUE OF MONEY


     The general concept of time value of money is very simple. Under this concept the value of money received
    today is more than the value of same amount of    money received after a certain period.   
     Actually the value of money received today is more than the value of the same amount receivable after 7 /12
    years. In reality sooner the money receives is better.
    Money has time value:       
            These are the following reasons that money has a time value.
     Uncertainty and risk: future is always uncertain and risky. Outflows are in our control. There is no certainty
    for future cash inflows. Inflows are dependent on other’s convenience. People prefer to receive ,immediately ,than
    waiting for the uncertain tomorrow.
     Present needs are more important: individuals generally prefer current consumption. Even a child wants an
    ice cream today rather than tomorrow.
     Opportunity to invest: An investor can profitably employ a rupee/ dollar received today to give him a
    higher value to be received tomorrow or after a certain period.
     More purchasing power in inflationary economy: in an inflationary economy, today’s rupee/dollar has
    more purchasing power to buy , rather than the same amount of money can buy at a later date.
    IMPORTANCE OF TIME VALUE
     The objective of FM is wealth maximization rather than the profit
    maximization as the later ignores the principle of time value of money.
     All financial decisions recognize the importance of this concept. When assets are purchased ,funds out go
    occurs, immediately, while returns in the form of inflow occur in future.
     Time value of money or time preference for money means the same. This is one of the central ideas of
    finance for decision making.
    SIMPLE AND COMPOUNDED INTEREST
     Interest:
     Interest is the rent paid for the use of money for some period of time.
     The amount of money paid or received in excess of the amount of money borrowed or lent (principal).
     Simple interest
     Simple interest means that the interest is earned only the principal sum of money invested.
     It is computed as: Interest = Principal x Rate x Time
     Compound Interest   
     Compound interest means, the principal earn interest and accumulated interest earns interest
     Used in most long-term business transaction.
    Example: Rate 6%; Principal = $ 100; Year = 3 years
    Simple Interest Compound Interest
    Year Computation Interest Total Year Computation Interest Total
    1 (100 x 0.06) 6 106 1 (100 x 0.06) 6 106
    2 (100 x 0.06) 6 112 2 (106 x 0.06) 6.36 112.36
    3 (100 x 0.06) 6 118 3 (112.36 x 0.06) 6.74 119.10
     Techniques of time value of money
     There are 2 techniques for adjusting the time value of money, they are
    1. Compounding technique
    2. Discounted or present value of technique.
     Types of annuity
     Ordinary annuity
     Future value ordinary annuity
     Present value ordinary annuity
     Annuity due
     Future value annuity due
     Present value annuity due
    Difference b/n annuity and annuity due
     When the cash flow or installment occurs at the end of each period, it is called regular annuity or deferred annuity.
     When the cash flow or installment occurs at the beginning of each period it is called annuity due.
    Annuity Due (Annuity in Advance)
    • Where rents occur at the beginning of the future and present.
    • Receipt / Rents occur at the beginning of the period.
    • Number of compounded periods always equal with the number of rents.
    • It is classified
    • Future value annuity due
    • Present value annuity due
    Future value annuity due
    • It is the amount accumulated at compound interest through a series of rent one period after the final rent is made.
    • At the beginning and ending period earns interest.
    • Graphic representation of present value annuity due for four equal payment:
    FUTURE VALUES—COMPOUNDING
     A dollar in hand today is worth more than a dollar to be received tomorrow because of the interest it could
    earn from putting it in a savings account or placing it in an investment account. For the discussion of the concepts of
    compounding and time value, let us define:        Fn = P(1+i) n=P.FVIFi.n
    Intra-year    Compounding
     Interest is often compounded more frequently than once a year. Banks, for example, compound interest
    quarterly,    and even continuously. If interest is compounded m times a year, then the general formula for solving for
    the future value becomes…. Fn = P(1+i/m)n.m=P.FVIFi/m.n.m
    Future Value of an Annuity
     An annuity is defined as a series of payments (or receipts) of a fixed amount for a specified number of
    periods.
    PRESENT VALUE—DISCOUNTING
     Present value is the present worth of future sums of money. In connection with present value calculations,
    the interest rate i is called the discount rate.      P=Fn/(1+ i)n= Fn[1/(1+ i)n= Fn. PVIFi.n
    Present Value of an Annuity
     Interest received from bonds, pension funds, and insurance obligations all involve annuities. To compare
    these financial instruments, we need to know the present value of each. The present value of an annuity ( Pn) can be
    found by using the equation:
          Perpetuities
     Some annuities go on forever. Such annuities are called perpetuities.
     An example of a perpetuity is preferred stock which yields a constant dollar dividend indefinitely. The
    present value of a perpetuity is found as follows:
        Present value of a perpetuity =receipt /discount rate =A/i
    APPLICATIONS OF FUTURE VALUES AND PRESENT VALUES
     Future and present values have numerous applications in financial and investment decisions. Five of these
    applications are presented below
          1. Deposits to Accumulate a Future Sum (or Sinking Fund)
          2. Amortized Loans(a loan is to be repaid in equal periodic amounts)
    3. Annual Percentage Rate (APR)              4. Rates of Growth                5. Bond Values
    1.Deposits to Accumulate a Future Sum (or Sinking Fund)
                                              A=Sn/FVIFAi;n
    2. Amortized Loans (a loan is to be repaid in equal periodic amounts)
                      Amount of loan = A=Pn/PVIFAi;n
    3.Annual Percentage Rate (APR)
                        APR=(1+r/m)m-1.0
    4. Rates of Growth
                        Fn= P. FVIFi;n
    5.Bond Values
                        V=I(PVIFAr,n)+M(PVIFr,n)

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