What is the Finance time value of money?

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Susan Kelly

Jan 04, 2022

The fundamentals of the Time Value of Money(TVM)


The following are key terminology and topics in the study of the time value of money:


(1) Cash-Flow: Single payment or a series over a period of time might be considered a cash flow event. Both single and multi-currency cash flows can be broken down into two basic categories: or even uneven cash flows.


(2) Cash Inflow: When a person or an organization makes a financial investment in a project or an asset, the money they receive is credited to their bank accounts. An even or uneven/mixed number of lump amounts may be paid out over a period of time.


(3) Cash Outflow: As opposed to the initial investment in a project or an asset, cash outflow represents payments made over time in order to acquire an asset or get a project that was originally invested in.


(4) Discounted Cash Flow - Time Value Mechanics: At any given time, a decision-maker can look at their "present value," or how much money they have now compared to their expected future cash flow. For the purpose of computing how much money will be paid out in the future, discounting is a process that is used (or receipts). Compounded interest rate in use for discounted future cash flows, known as "discount rates."


(5) Annuity cash flow is the same as even cash flow: As with annuities, which are cash flows which occur over an extended period, such as one year or more, even cash flows are also characterized as such. Another definition of an annuity is 'a series of recurring income or payments over a period of time as a result of an initial investment.'


(6) Cash Flows That Aren't Even or Mixed: Another way to say this is that an unequal cash flow is once you have a stream of money streaming into your firm at an inconsistent rate.


(7) Single Cash Inflows: The discount factor is multiplied by the cash inflow to get the current value of a specific cash inflow. ' This cash inflow indicates the overall amount of money that the project has brought in over the chosen time period.


(8) Multiple Cash Inflows: Multiple cash flows are cash inflows generated by a project over its lifetime, which can include annuity and mixed streams of inflows from the asset.


(9) Future Value/Compound Value [FV/CV]: The notion of future value describes how much a current cash flow or series of cash flows will be worth at a specific discount or interest rate at the end of a defined time period. If you invest or borrow money now at a certain return or interest rate, you'll get that same amount back at the conclusion of a certain term later on in the future at some future value. When we talk about "future value," we're talking about how much money will be worth at some future date and time, based on a certain time preference rate for money.


Compounding: Compounding is a method for estimating how much money will be worth in the future. It is the process that investing money, reaping the benefits of interest, and reaping the benefits of compounding over time. Compounding is the process of calculating an investment's maturity value based on the initial investment. Compounding makes the original principle part of the final principal. Compounding refers to the time value of money strategy where interest continues to generate interest during the asset's lifetime.


FV or CV = PV (1 + i)n


Present Value: The present value is the antithesis of the future. For example, if an interest rate or return is supplied, the present value of a future quantity of money or stream of cash flows is determined. It's also known as a discount value. A future cash flow or sequence of cash flows is what it is called today.


Discounting: Discounting is the opposite of compounding. Using discounting, you may figure out what the current value for future cash flows will be in the present. Discounting, also known as Present Value, is more popular that compounding as a result of people's preference for time-based money.


All financial choices benefit greatly from the time value of money notion


(1) To assess the viability of initiatives by comparing investment options.


(2) Accepting or rejecting investment offers in order to choose the best ones.


(3) Calculating interest rates and resolving issues associated with loans, mortgages, leasehold improvements (HMOs), savings, and annuities are all examples of this.


(4) Find out how long it will take for the initial investment to be recouped, as well as the estimated rate of return.


(5) Helps to stabilize wages and prices.


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