DBB2104: Financial Management Manipal University Jaipur (MUJ)

BACHELOR OF BUSINESS
ADMINISTRATION
SEMESTER 3

DBB2104
FINANCIAL MANAGEMENT

Unit 4: Time Value of Money 1

DBB2104: Financial Management Manipal University Jaipur (MUJ)

Unit 4
Time Value of Money
Table of Contents

SL Topic Fig No / Table SAQ / Page No

No / Graph Activity
1 Introduction 1
1.1 Learning Objectives 1
1.2 Time Value of Money – Definitions
1.3 Time Value of Money – Concepts:
Explanation, Calculation, Formula and
3 - 11
Examples
1.4 Importance of Time Value of Money
1.5 The Significance of Time Value of
Money
1.6 Reasons for Time Preference of Money
2 Techniques for Estimating Time Value of 2 2 12 - 24
Money
2.1 Compounding Technique or Future
Value Technique
2.2 Discounting Technique or Present
Value Technique
3 Summary 25
4 Glossary 26
5 Terminal Questions 26 - 27
6 Answers 27 - 30
7 Suggested Books and E-References 31

Unit 4: Time Value of Money 2

DBB2104: Financial Management Manipal University Jaipur (MUJ)

1. INTRODUCTION

Time value of money is one of the most important principles of financial management. The
time value theory is based on the fact that money has a time value. In other words, a rupee
received today is worth more than a rupee received a year from now. Three variables affect
the time value of money.

First, there’s the simple ‘bird-in-hand’ principle, which states that uncertainty increases with
time, so a promise of one rupee in ten years is usually worth less than a similar promise made
in one year. When it comes to making investment decisions, the bird-in-the-hand principle
is extremely important.

Second, under inflationary conditions, rupee’s purchasing power diminishes over time. If
inflation continues, future value of rupee will diminish compared to their current value.

Third, any expenditure comes with an opportunity cost, which makes future rupee less
valuable than current ones. Because a rupee today can be profitably invested, it will be worth
more than a rupee in the future, resulting in opportunity costs.

1.1 Learning Objectives

After studying this chapter, you will be able to:
❖ Compare compounding and discounting techniques
❖ Analyze the significance of time value of money
❖ Explain the concept of time value of money

Unit 4: Time Value of Money 3

DBB2104: Financial Management Manipal University Jaipur (MUJ)

1.2 Time value of money – definition

Scholars have defined time value of money in many ways. Some of them have been given
below:

According to I M Pandey, “An individual’s preference for possession of a given amount of

cash now rather than the same amount at some future time called time preference for
money.”

According to E A Kolb, “Time value of money refers to the fact the same money return has a
higher present value than it is to be received later.”

Benton defines it as, “The principle that money received in the present is worth more than
the same amount received in the future.”

It is defined the value extracted from the use of money over time as a result of investment
and reinvestment. The preference for money now over money later is known as time
preference for money.

The term “time value of money” refers to the fact that money received today is more valuable
than money received later; money received in the future, on the other hand, is less valuable
than money received today.

To put it another way, the current value of a rupee earned over time is less than the current
value of a rupee received today.

1.3 Time value of money – concepts: explanation, calculation, formula and

examples

The time value of money is a fundamental concept in financial decision-making. Any decision
that ignores this fundamental concept is doomed to fail. It is also called the ‘Discounting
Principle’. It is crucial in any decision where operations are spread out over a long period of
time or where we must make intertemporal decisions.

Unit 4: Time Value of Money 4

DBB2104: Financial Management Manipal University Jaipur (MUJ)

Similarly, we would prefer to pay any amount in the future rather than now because paying
now is more difficult, whereas paying the same amount in the future is easier.

The time value of money is based on the assumption that lending opportunities will always
exist and that the interest rate will always be positive. It means that if we receive money
now, we can always lend it out and earn interest in the future.

As a result, this amount will be greater than a similar sum of money that will be received at
a later date. This is known as future discounting.

The discounting of the future is done to account for the time difference between the present
and the future, and the greater the discounting, the further away the future is. As a result,
discounting bridges the gap between the present and the future, and it does so at the current
interest rate which is compounded.

The entire procedure can be summed up as follows

Assume that the interest rate is 10% per year.

If we receive a sum of Rs. 500 now, it will earn Rs. 50 in interest over the next year, bringing
the total to Rs. 550. In the second year, the same sum will earn Rs. 55 in interest, bringing
the total to Rs. 605 after two years. The following compound interest formula can be used to
calculate how much money grows over time.

𝑟
𝐴 = 𝑃 [1 + ]
100
Where;
A is the maturity / future value of money
P is the principal sum or present value of the money
r is the rate of interest percent
T is the time period for which future sum is being calculated.

How does the value of a given sum of money change over the time scale is shown in the
following figure?

Unit 4: Time Value of Money 5

DBB2104: Financial Management Manipal University Jaipur (MUJ)

Fig 1: Time Scale Showing Value Over Time

In the diagram above, different values are shown for various time periods. These are the
values of the same Rs. 500 at various points in time, assuming a ten percent annual interest
rate. After one year, Rs. 500 becomes Rs. 550, Rs. 605 after two years, and Rs. 805.26 after
five years. All sums have the same value in terms of valuation.

The above-mentioned compound interest formula was used to calculate all of these figures.
This well-known compound interest formula can be tweaked a little to make things easier
for us. We use the symbol I for rate per rupee instead of the letter ‘r’ for rate percent.

Accordingly, the modified formula would be

A = P(1 + i)𝑡

We see that the formula is the same. Only ‘r’ has been replaced by ‘i’. Now, if we try to find
the value of ‘i’ for corresponding values of ‘r’, it would be as follows

and so on.
In the above example of Rs. 500, if we want to find its value after 5 years it will be:
=500 (1+.1)5
= 500 (1+.1)5

Unit 4: Time Value of Money 6

DBB2104: Financial Management Manipal University Jaipur (MUJ)

=500 (1.6105)
= 805.25
Similarly, its value can be calculated for any point of time in future.

Now, if our objective is to calculate the present value of any sum of money, that is payable in
future, we can use it as follows.

1
p=
(1 + i)𝑡

If a sum of Rs. 500 is to be received after four years and we need to calculate its present value,
we can do so as follows (assuming the same rate of interest):

500
p=
(1 + 1)4

500 500
= 4
=
(1. 1) 1.4641

= Rs. 341.50

Thus, the discounted value of Rs 500 payable/receivable after four years is Rs 341.50. We
can find the discounted value of any sum of money payable or receivable at a future date in
this way.

Compounding and discounting are the two sides of the same coin. Compounding is the
process of carrying current values into the future, while discounting is the process of
transferring future values into the present. Discounting decreases the value while
compounding increases it. Both are outcomes of the same concept, namely, the time value of
money.

The impact of compounding or discounting is now obvious to the readers, as it is dependent

on the time period and the interest rate or discount rate. When the discount rate is high, the
value is reduced more and vice versa.

If the interest rate or discount rate is set at 12% in the above example, the present
value of Rs. 500 payable/receivable after 4 years is Rs. 500.

Unit 4: Time Value of Money 7

DBB2104: Financial Management Manipal University Jaipur (MUJ)

500 500
= = = Rs. 317.76
(1.12)4 1.5735

Similarly, if discounting is done for 6 years at the same 10 percent, the present value of the
same Rs. 500 would be

500 500
= = =Rs. 282.23
(1.1)6 1.7716

This value is lower than what we get if we discount it only for four years. Discounted values
for various rates and time periods can be found in this manner.

1.4 Importance of time value of money

The time value of money is extremely important when making financial decisions. In finance
and economics, it is one of the most important theories. The following are the reasons which
makes it important.
(i) Inflation
The rupee today has a higher buying power than the rupee in the future due to inflation.
As a result, those who must earn money tend to spend as soon as possible, while those
who must pay money attempt to postpone payment.
(ii) Uncertainty
Since the future is unpredictable, people and businesses tend to have current income
rather than waiting for the same payment later. They are concerned that the party
making the payment would default due to insolvency or other circumstances.
(iii) Preference for present consumption
Individuals prefer current consumption to potential consumption due to both volatility
and inflationary conditions. They don’t want to plan for the future by cutting back on
current spending.

Unit 4: Time Value of Money 8

DBB2104: Financial Management Manipal University Jaipur (MUJ)

(iv) Opportunities for reinvestment

Money can be put to good use in order to produce real results. Individual businesses
reinvest money at a certain pace in order to earn a profit.

As a result, when making financial decisions, a financial manager of a business cannot

disregard the principle of time value of money; otherwise, his decisions would be
invalid and wrong.

1.5 The significance of time value of money in finance

The maximization of the economic wellbeing of shareholders is the aim of financial decision
models based on finance theories. A basic concept in finance is that money earned now is
worth more than money earned later.

To a larger degree, the idea of the time value of money applies to this factor. The importance
of the time value of money principle can be summarized as follows:

Investment decision

The allocation of capital into long-term investment ventures is the subject of the investment
decision. Long-term investment cash flow happens at a different point in time in the future.
In other words, investment decisions are concerned with whether adding to capital assets
today will increase tomorrow’s revenues to cover costs. They are not comparable to one
another or to the cost of the project as it stands now. Future cash flows are discounted back
to present value to make them comparable. As a result, investment decisions are concerned
with the acquisition of real assets over a period of time in the course of a productive process.

Investors in securities benefit from understanding the principle of time value of capital.
When investing in securities such as stocks and bonds, they use valuation models. The time
value of cash flows from securities is taken into account in these security valuation models.

Financing decision

Designing an optimal capital structure and raising funds from the lowest-cost sources are
important considerations in the financing decision. The time value of money principle is also
useful in financing decisions, especially when comparing the costs of various financing

Unit 4: Time Value of Money 9

DBB2104: Financial Management Manipal University Jaipur (MUJ)

options. “It is concerned with the borrowing and allocation of funds required for investment
decisions. The effective rate of interest of each source of financing is calculated based on the
time value of money concept. The financial decision’s objective is to maintain an optimum
capital structure, i.e., a proper debt-to-equity ratio to ensure a risk-to-return trade-off for
shareholders”

In addition, the time value of money is used to evaluate new credit policies as well as the

firm’s efficiency in handling cash collection under current asset management.[2]

Time Preference of Money

“If you have the option of getting Rs. 1,000 today or in a year, you would almost certainly
choose today. This is because the present value of a money is greater than the value of a
money in the future.”

1.6. Reasons for time preference of money

The following are the reasons for time preference of money:
1. Present needs are considered more important
People prioritize their present needs over their long-term ambitions. Purchasing
clothing, a television, a car, and other large-ticket things feels more urgent than saving
for the future. As a result, people value money today more than they do tomorrow.
2. Available investment opportunities
If you give someone Rs 1,00,000 today and he invests it at a rate of 12% per year, he
will have Rs 1,12,000 at the end of the year (Rs 1,00,000 + Rs 1,00,000 X 12/100). If he
was to receive the same sum after one year, he would only receive Rs 1,00,000.
Investing in stocks has the potential to double one’s capital in a short period of time. As
a result, a person would prefer to receive a certain sum of money now rather than later.
3. Loss and uncertainty
The future is unknown. If you expect to receive a certain amount in the future, there is
always the possibility that you will not receive it. The future is fraught with dangers. A
person may suffer a loss if they do not receive the anticipated amount in the future. As
a result, a person would prefer to receive money today.[3]

Unit 4: Time Value of Money 10

DBB2104: Financial Management Manipal University Jaipur (MUJ)

Self-Assessment Questions -1
1. Time value of money means that the value of a sum of money received today is
more than its value received after some time. (True/False)
2. Money doesn’t lose its value over time which makes it more desirable to have it
now rather than later. (True/False)
3. People normally consider present needs as more important than their future
needs. (True/False)

Unit 4: Time Value of Money 11

DBB2104: Financial Management Manipal University Jaipur (MUJ)

2. TECHNIQUES FOR ESTIMATING TIME VALUE OF MONEY

There are two methods for calculating time value of Money:

1. Compounding Technique or Future Value Technique

2. Discounting Technique or Present Value Technique

Sources: https://qsstudy.com/finance/difference-between-discounting-and-compounding
Fig 2: Techniques for Estimating Time Value of Money

2.1 Compounding technique or future value technique

Money has a preference for now over the future, which promotes people to obtain money
now rather than later. He may be willing to wait, though, if he is sufficiently compensated for
his time by obtaining additional money in the future. If someone is offered Rs1,000 today, he
will wait a year if he is guaranteed Rs1,100 at the end of the year, assuming a 10% annual
rate of return.

The following are the different types of compounding or future value techniques:

1. Future value of a single flow

2. Future value of multiple flows
3. Future value of an annuity

Unit 4: Time Value of Money 12

DBB2104: Financial Management Manipal University Jaipur (MUJ)

1. Future Value of a Single Flow [Lump Sum]

The future value of a lump sum can be calculated by using the following formula

FV = P[1 + in ]
Where;
FV = Future Value
P =Principal
i = Rate of interest per unit i.e., [R/100]
n=number pf years

Illustration-1
Calculate the future value of Rs 50,000 after three years at a rate of interest of 12% per
year.
Solution
FV = P[1 + in ]
=50,000[1.123 ]
=50,000[1.405]
=70,250

2. Future Value of Multiple Flows or a Series of Flows

We’ve just looked at the future value of a single flow so far. However, we can invest
different amounts at different times in several cases.

Future Value can be determined in this case as follows:

(i) When the investments occur at the end of each period:

FV = P1[1 + i]n−1 + P2[1 + i]n−2 + P3[1 + i]n−3 + ⋯ … … … … … … … … + Pn

Where;
FV = Future Value
P =principal
i =Rate of interest per unit
n = number of years

Unit 4: Time Value of Money 13

DBB2104: Financial Management Manipal University Jaipur (MUJ)

Illustration-2
Calculate the future value of the following sequence of payments after 5 years at an
interest rate of 8%.
At 1st year end Rs1,000
At 2nd year end Rs2,000
At 3rd year end Rs3,000
At 4th year end Rs4,000
At 5th year end Rs5,000 Solution

Solution:

FV = P1[1 + i]n−1 + P2[1 + i]n−2 + P3[1 + i]n−3 + P4[1 + i]n−3 + Pn

= 1,000[1.084 ] + 2,000[1.083 ] + 3,000[1.082 ] + 4,000[1.081 ] + 5000

= 1,000[1.36] + 2,000[1.26] + 3,000[1.17] + 4,000[1.08] + 5,000

=1,360 + 2,520 + 3510+ 4,320 + 5,000

=16,710

(ii) When the investments occur at the beginning of each period

FV = P1[1 + i]n + P2[1 + i]n−1 + P3[1 + i]n−2 + ⋯ … … … … … … … … + Pn[1 + i]

Where;
FV =Future Value
P = Principal
i = Rate of interest per unit
n = number of years

3. Future Value of an Annuity

The future value of an annuity is a way of calculating how much money a series of
payments will be worth at a certain point in the future.

Unit 4: Time Value of Money 14

DBB2104: Financial Management Manipal University Jaipur (MUJ)

(i)When the annuity occurs at the end of each period:

The annuity is called an immediate annuity when cash flows arise at the end of each
period. An immediate annuity’s future value can be estimated as follows:

𝑎
FV = [(1 + 𝑖)𝑛 − 1]
𝑖
Where;
FV = Future Value
a =Annuity or yearly payment
i = Rate of interest per unit
n = number of years

Illustration- 3

Mr. X deposits Rs10,000 at the end of each year for four years, earning a compounded
interest rate of 10% per year. Calculate how much money he will have in fourth years.

Solution

10,000
FV = [(1.10)4 − 1]
0.10

= 1,00,000[0.4641]

=46,410

(ii) When the annuity occurs at the beginning of each period

The annuity due is one where the cash flows occur at the start of each period.

The following formula can be used to calculate the future value of an annuity due:

𝑎
FV = (1 + 𝑖)[(1 + 𝑖)𝑛 − 1]
𝑖
Where;
FV = Future Value
a = Annuity
i = Rate of interest per unit

Unit 4: Time Value of Money 15

DBB2104: Financial Management Manipal University Jaipur (MUJ)

n = number of years

In the case of multi-period compounding, the effective rate of interest is

When interest is compounded annually, the nominal rate of interest becomes the effective
rate of interest. However, when interest compounding is done at a frequency of less than one
year, the rate of interest received by the investor for one year is more than the specified
nominal rate. This is referred to as the effective interest rate. Compounding can be done on
a semi-annual, quarterly, monthly, or any other fraction of a year basis in certain instances.

𝑖 𝑛
ERI = (1 + ) − 1
𝑚

Where;
ERI = Effective rate of interest
m = Frequency of compounding
i = Nominal rate of interest

Illustration-4

On deposits, a company offers a 10% interest rate. If compounding is done a) monthly, b)

quarterly, c) half-yearly, what is the effective rate of interest?

Solution

(i) When the compounding is done monthly

𝑖 𝑛
ERI = (1 + ) − 1
𝑚

0.10 12
= (1 + ) −1
12

= 1.1042-1
=0.1042
=10.42%

Unit 4: Time Value of Money 16

DBB2104: Financial Management Manipal University Jaipur (MUJ)

(ii) When the compounding is done Quarterly

0.10 4
ERI = (1 + ) −1
4

= 1.1038-1
=0.1038 = 100
=10.38%

(iii) When the compounding is done half yearly

0.10 2
ERI = (1 + ) −1
2

= 1.1025 - 1
=0.1025
= 10.25%

Doubling Period

It is the amount of time it takes to double an investment. Financial advisors and investors
want to know how long it will take for their investment to double. The rate of interest is used
to calculate it. The doubling period is shortened when the interest rate is higher, and vice
versa.

(i) Rule of 72
(ii) Rule of 69

a. Rule of 72:
According to this rule,
72
Doubling period =
Rate of Interest
Rate of Interest (%) Calculation Doubling period
6 72/6 12 years
12 72/12 6 years
16 72/16 4.5 years

Unit 4: Time Value of Money 17

DBB2104: Financial Management Manipal University Jaipur (MUJ)

b. Rule of 69
According to this rule.
60
Doubling period = 0.35 +
Rate of Interest
Rate of Interest (%) Calculation Doubling period
6 0.35+69/6 11.9 years
12 0.35+69/12 6.1 years
16 0.35+69/16 4.6 years
18 0.35+69/18 4.1 years

Illustration-5

Mr. X makes a deposit of Rs 10,000 on January 1, 2012, at a rate of 10%. How long do you
think it would take to double this amount? Work out this problem by using:

(i) Rule of 72 and

(ii) Rule of 69

Solution
a) Rule of 72
72
Doubling period =
Rate of Interest
72
=
10
=7.2 years
b) Rule of 69
69
Doubling period = 0.35 +
Rate of Interest
69
=0.35 +
10
= 0.35 + 6.9
= 7.25 years

Unit 4: Time Value of Money 18

DBB2104: Financial Management Manipal University Jaipur (MUJ)

2.2 Discounting technique or present value technique

The present value of money is the value of money today that will be received in the future.
It’s the present value of money after it’s been discounted at a certain interest rate. To put it
another way, present value depicts the current value of a future sum of money.

The following are the different types of discounting or present value techniques

1. Present value of a single flow

2. Present value of multiple flows
3. Present value of an annuity

1. Present Value of a Single Flow

The following formula can be used to calculate the present value of a sum of money received
after ‘n’ years:

A
P. V. =
[1 + i]n
Where;
PV= Pr esent value
A= Amount at the end of the period ‘n’
i = Interest rate
n = Number of Years

Illustration-6

After 5 years, Mr. X will receive Rs 20,000 from Indira Vikas Patra. He prefers capital over
time by 10% a year. Calculate its present value.

Solution:
A
P. V. =
[1+i]n

20000 1
P. V. = = 20.000 × = 20,000 × 0.621 = 12,420
[1.10]5 (1.10)5

Unit 4: Time Value of Money 19

DBB2104: Financial Management Manipal University Jaipur (MUJ)

2. Present Value of Multiple Flows or a Series of Flows

Illustration-7
Calculate the present value of the following cash flows using an 8% annual discount rate.
Year Cash flows [₹]
1 20,000
2 40,000
3 20,000
4 10,000

Solution:

Calculation of Present Value

Year Cash inflow PV factor at 8% Present Value
1 20,000 0.926 18,520
2 40,000 0,857 34,280
3 20,000 0.794 15,880
4 10,000 0.735 7,350
Total Present Value 76,030
Note: PV factor at 87 can be calculated as follows
1
1st Year = 0.926
1.08
0.926
2nd Year =0.857
1.08

3. Present Value of an Annuity

An annuity is a series of equal cash flows distributed over a set number of periods.

The following formula can be used to calculate the present value of an annuity value A for
‘n’ years at an effective rate of interest

Present value of annuity due:

1
1−
(1 + i)n
PV = 𝐴 [ ]
𝑖

Where;

Unit 4: Time Value of Money 20

DBB2104: Financial Management Manipal University Jaipur (MUJ)

A = Amount at the end of the period ‘n’

i = Interest rate per unit
n = Number of years
PV = Present value

Illustration-8

Determine the present value of an annuity of Rs1, 00,000 receivable for 5 years at an effective
rate of interest of 12% p.a.

Solution:

1
1−(1+i)n
PV = 𝐴 [ ]
𝑖

100000 1
PV = [1 − (1+0.12)5 ]
0.12

= 8,33,333[1 − 0.5674]

=8,33,333[0.4326]

=3,60,500

Self-Assessment Questions -2
4. When cash flows occur at the end of each period, the annuity is called immediate
annuity. (True/False)
5. Higher rate of interest reduces the doubling period and vice versa. (True/False)
6. Financial advisors and investors are not interested in knowing the period in
which their investment will be doubled. (True/False)

Unit 4: Time Value of Money 21

DBB2104: Financial Management Manipal University Jaipur (MUJ)

3. SUMMARY
• Among all the concepts and principles used in financial management, the time value of
money is one of the most important concepts. Money has a time value, which is the crux
of the time value concept.
• A rupee that will be received a year from now is not worth as much as a rupee that will
be received today. The purchasing power of the rupee depreciates overtime when
inflation is present.
• The value of future rupees will depreciate in comparison to the current value. Because
a Rupee can be profitably invested today, opportunity costs arise.
• Financial management’s basic goal is to maximize shareholder welfare, which is
superior to profit maximization because, among other things, the former considers the
timing of benefits received, whereas the latter does not. This necessitates sound
financial management decisions on financing, investment, and dividends.
• The concept of the time value of money states that the value of a rupee received in the
future is less than its current value. Money loses its value over time, so having it now
rather than later is preferable.
• The concept of time value is based on the assumption that cash flows occur at different
times. Timelines are an important component of money’s time value.
• The “time preference for money” is another term for the Time Value of Money. A
decision-maker incurs an opportunity cost equal to the income that could have been
earned on the next best alternative by choosing to use resources over another.

Unit 4: Time Value of Money 22

DBB2104: Financial Management Manipal University Jaipur (MUJ)

4. GLOSSARY
TVM: Time value of money
FM: Future value
PV: Present value
P: Principal
n: Number of years
a: Annuity
i: Rate of interest

5. TERMINAL QUESTIONS
Short Answer Questions
Q1. Explain the concept of time value of money.
Q2. Elaborate the importance of time value of money.
Q3. Explain the reasons for time preference of money.
Q4. Calculate the future value of Rs50,000 at the end of 3 years at 12% per annum rate of
interest.
Q5. Calculate the present value of the following cash flows assuming a discount rate of 8%
p.a.
Year Cash flows [₹]
1 20,000
2 40,000
3 20,000
4 10,000

Long Answer Questions

1. Explain the meaning of time value of money along with its importance.
2. Explain the techniques for estimating time value of money.

Unit 4: Time Value of Money 23

DBB2104: Financial Management Manipal University Jaipur (MUJ)

6. ANSWERS
Self-Assessment Questions
1. True
2. False
3. True
4. True
5. True
6. False

TERMINAL QUESTIONS

Answer 1: The time value of money is a fundamental concept in financial decision-making.

Any decision that ignores this fundamental concept is doomed to fail. The ‘Discounting
Principle’ is another name for this concept. This is crucial in any decision where operations
are spread out over a long period of time or where we must make intertemporal decisions.

The time value of money concept states that the value or real worth of any amount of money
is determined by “the point in time when it is received or paid.” If a sum is received now, it
is worth more than if the same sum is received later.

Similarly, we would prefer to pay any amount in the future rather than now because paying
now is more difficult, whereas paying the same amount in the future is easier.

The time value of money is based on the assumption that lending opportunities will always
exist and that the interest rate will always be positive. It means that if we receive money
now, we can always lend it out and earn interest in the future.

Answer 2: In financial decisions, the time value of money holds great importance. It is now
the most significant principle in finance and economics. There are certainly valid reasons for
this state of affairs.

Unit 4: Time Value of Money 24

DBB2104: Financial Management Manipal University Jaipur (MUJ)

A few are
(i) Inflation
The rupee today has a higher buying power than the rupee in the future due to
inflationary conditions. As a result, those who must earn money tend to do so as soon
as possible, while those who must pay money attempt to postpone payment.

(ii) Uncertainty
Since the future is unpredictable, people and businesses tend to have current income
rather than waiting for the same payment later. They are concerned that the party
making the payment would default due to insolvency or other circumstances.

(iii) Preference for Present Consumption

Individuals prefer current consumption to potential consumption due to both
volatility and inflationary conditions. They don’t want to plan for the future by cutting
back on current spending.

(iv) Opportunities for reinvestment

Money can be put to good use in order to produce real results. Individual businesses
reinvest money at a certain pace in order to earn a profit.

As a result, when making financial decisions, a financial manager of any business

concern cannot disregard the principle of time value of money; otherwise, his
decisions would be invalid and wrong.

Answer 3:

The reasons for time preference of money are as follows:

1. Present needs are considered as more important
People prioritize their immediate needs over their long-term goals. Buying clothing, a
tele- vision, a car, and other expensive items for immediate use feels more pressing than
saving for the future. As a result, people regard today’s worth of money as greater than
tomorrow’s value.

Unit 4: Time Value of Money 25

DBB2104: Financial Management Manipal University Jaipur (MUJ)

2. Investment Opportunities Available

If you give someone Rs10,000 today and he invests it at 12% per year, at the end of the
year, he will have Rs11,200 (Rs10,000 plus Rs10,000 X 12/100). He would receive only
Rs10,000 if he were to receive the same sum after one year. It is possible to double one’s
money in a short period of time by investing in stocks. As a result, an individual would
rather obtain a certain amount of money today than after a certain period of time.

3. Uncertainty and Loss

Future is uncertain. “If you expect to receive a certain amount in future, there is always
an uncertainty with regard to its receipt in future. The future is subject to risks. A
person may incur loss due to not getting the expected amount in future. So, a person
prefers to receive the money today”

Answer 4:
FV = P[1 + i]n
= 50,000[1.12]3
= 50,000[1.405]
= 70,250

Answer 5

Solution

Calculation of Present Value

Year Cash inflow PV factor at 8% Present Value
1 20,000 0.926 18,520
2 40,000 0,857 34,280
3 20,000 0.794 15,880
4 10,000 0.735 7,350
Total Present Value 76,030

Note: PV factor at 87 can be calculated as follows

Unit 4: Time Value of Money 26

DBB2104: Financial Management Manipal University Jaipur (MUJ)

1
1st Year = 0.926
1.08

0.926
2nd Year =0.857
1.08

LONG ANSWER QUESTIONS

Answer 1:
The time value of money is a fundamental concept in financial decision-making. Any decision
that ignores this fundamental concept is doomed to fail. It is crucial in any decision where
operations are spread out over a long period of time or where we must make intertemporal
decisions

Answer 2:
There are two methods for calculating time value of Money:

1. Compounding Technique or Future Value Technique

2. Discounting Technique or Present Value Technique

7. SUGGESTED BOOKS AND E-REFERENCES

• https://www.economicsdiscussion.net/financial-management/time-value-of-
money/32809
• https://www.assignmentpoint.com/business/finance/significance-of-time-value-of-
money.html
• https://www.businessmanagementideas.com/financial-management/time-value-of-
money/time-value-of-money/19098
• Pandey I M, Financial Management, Vikas Publishing House.
• Khan MY & Jain PK, Financial Management: Text, Problems and Cases, Tata McGraw-
Hill.
• Chandra P., Financial Management: Theory and Practice, Tata McGraw-Hill.
• Bhat Sudhindra, Financial Management: Principles and Practice, Excel Books.
• J.V. Horne & J.M. Wachowicz, Fundamentals of Financial Management, Prentice-Hall

Unit 4: Time Value of Money 27