Time Value of
Money (TVM)
Time value of money is the value of money that changes over
a period of time. The value of money received today is more than its value
received at a later date, which means that the value of money increases day by
day. For example 100 rupees note today is more valuable than the 100 rupees
after one year. The additional money along with the 100 rupees at the end of the
year is called as interest or time value of money.
Suppose say am giving you two options
1.
I am offering you 1000 rupees today or
2.
I am offering you 1000 rupees after 2 years.
What would you prefer?
You would select 1000 rupees
today and deposit the same in the bank which will give the interest amount of
1050 at the end of the 2 years. If you
ignore this concept of TVM then you will not be able to make good personal or
business decision.
There are 5 models in time value
of money:
1.
Future Value (FV)- It is a compounding process
which means as time and our interest rate increases and value increases
2.
Present Value(PV)- It is a discounting process
which means as the time and our interest
rate increases and value decreases
3.
Future Value of Annuity(FVA)
4.
Present Value of Annuity(PVA)
Future value and present value models are used for single sum and when
you have stream of payments of equal amount and equal in trouble then future
value of annuity and present value of annuity models are used for time value of
money amounts
5.
Loan Amortization Analysis- this is used for
loan analysis
The first step in time value of money analysis is to draw a time line to
clarify the analysis on hand.
PV
FV
0 1 2 3 4 5
If you see the figure the value of money increases at equal
interval of time .There are 3 variables in time value of money:
1.
Interest rates
2.
Number of periods
3.
Future value and present value
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