Page 22 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Unit 2: Time Value of Money

Objectives Notes

After studying this unit, you will be able to:

Learn about the concept of time value of money
Discuss various techniques of calculating the time value of money
Calculate the time value of money in single
Calculate the value of money in series

Introduction

Like any business enterprise, every individual wants to maximize his wealth and money. This
requires him to take appropriate decisions on financing, investment and dividends. While
taking these decisions, the individual must keep the “Time factor” in mind.

For example,
(i) When interest on funds raised will have to be paid.
(ii) When return on investment will be received.
(iii) Whether it will be received on a consistent basis or otherwise etc.
All this requires that the person should know about the various valuation concepts, viz.,
Compound Value Concept, Annuity Concept, Present Value Concept etc. All these concepts are
basically based upon the fact that, money has time value.
2.1 Meaning of Time Value of Money

“Money has time value” means that the value of money changes over a period of time. The value
of a rupee, today is different from what it will be, say, after one year.

Money has a time value because of the following reasons:
(i) Individuals generally prefer current consumption to future consumption.
(ii) 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.
(iii) In an inflationary economy, the money received today, has more purchasing power than
money to be received in future.
(iv) ‘A bird in hand is worth two in the bush’ : This statement implies that, people consider a
rupee today, worth more than a rupee in the future, say, after a year. This is because of the
uncertainty connected with the future.
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 some time.

Example: If an individual is given an alternative either to receive ` 10,000 now or after
six months; he will prefer ` 10,000 now. This may be because, today, he may be in a position to
purchase more goods with this money than what he is going to get for the same amount after six
months.
Time value of money or time preference of money is one of the central ideas in finance. It
becomes important and is of vital consideration in decision making. This will be clear with the
following example.

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