Time Value of Money

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

Depository Receipts

Depository receipt: DR

It is a financial instrument where a person in one country can buy, hold or sell his securities of a company in another country.  It is a certificate which consists of name of company, name of investor, number of shares taken, summary of depository receipt etc.

There are two types in Depository receipt:

·         Global Depository Receipt (GDR)

·         American Depository Receipt (ADR)

Global Depository Receipt:

This can be understood well with the help of an example:  Suppose let us say a European person wants to have an exposure in Indian securities, so he can do this in two ways:

One he can enter the Indian stock market and buy the company’s stock on one of the Indian markets. By this an investor will get exposed to the stock exchange and know the risks involved in it. He can also know the rules and regulations involved in purchase and sale of securities in the market.

Two he can know through the GDR which would give the investor ownership of the Indian company’s stock without being involved to Indian stock market regulations.

GDR is a global financial instrument which allows an investor to raise capital at the same time in two or more markets. Basically DR helps in cross-border and cross currency transactions.

GDR  can be listed in American and European stock exchange markets. A person from any country can buy securities  in any country and sell in any other country.

GDR can represent more than one share. They are in the US dollar.

One of the benefit of GDR as per my understanding

Once the issuing company has exploited the domestic capital markets, the company will not be benefitted in domestic market. The company will turn to international capital markets the base of investors.

One disadvantage of GDR

GDR’s have a foreign exchange risk if the currency of the issuer is different from the currency of the GDR( normally US dollar).

American Depository Receipt:

It represents ownership in the shares of a non-US company and trades in the American stock markets.

ADR enables American investors to buy shares in foreign company without any issue of cross border and cross currency transactions.

ADR’s carry price in American dollar,pay dividend in the same currency and can be traded like any other share of US based companies.

It can be listed in American Stock exchange.

ADR holder can have no right to vote in the company

Marginal Costing

Marginal Costing:

In our day to day life we come across lot of activities. It is essential to know about the costing for making our life easier and more beneficial. Let us understand the concept of marginal costing. I hope many of us may really not know much on this. We may know that it is a cost or some amount of money charged on a product.

To understand this well, I will start with a simple example.  Let us say, I have an ice cream shop and I manufacture 10000 cups of ice creams for 50000 Rs. Later I get an order for the same to manufacture 10001 cups of ice creams for 50002 Rs.

10000 cups – 50000 Rs so each will cost 5 Rs

10001 cups – 50002 Rs – here the extra one cup – will cost 2 Rs- this 2 Rs is considered as marginal cost.

So this additional cup was costing only for Rs. 2 and it did not cost more because it was only the variable cost and fixed cost such as salary, set up fees, insurance, tax will not increase when another additional unit is produced. Here can see that even though you manufacture additional units the cost is less and is beneficial.

One more example to make you understand better:

Everyone is now more conscious of their health and fitness. Many people want to go to gym for reducing weight. So let us say that you go to gym for 3 times a week due to time constraint and thinking of adding 2 more times, you would use marginal analysis. You will think whether going for extra 2 more days will help in reducing the weight or doing house hold work or weekend activities having less food will help. Marginal analysis is to analyze the additional benefits something in comparison of additional cost.

 If I have to take up a decision then I think a lot how will I spend my next one hour and also I will think how will I spend my one rupee. I will think of spending it at a less cost and look for more benefits. 

Let us solve a simple problem on marginal costing

Marginal cost = Total cost /Total out put 

A factory produces 500 mobiles per annum. The variable cost per mobile Rs.50 . The fixed expenses are Rs.10000 per annum. Thus the cost sheet of 500 mobiles will appear as:

Variable cost( _______* 50)                = 25000

Fixed cost                                                  ________

Total    =                                                     _________

If production is increased by one unit i.e. it becomes 501 fans per annum, the cost sheet will appear as:

Variable cost( _______* 50)                = _______

Fixed cost                                                  ________

 Marginal cost will be =                          _________