A finance manager is required to make decisions on investment, financing and dividend in view of the company's objectives. The decisions as purchase of assets or procurement of funds i.e. the investment/financing decisions affect the cash flow in different time periods. Cash outflows would be at one point of time and inflow at some other point of time, hence, they are not comparable due to the change in rupee value of money. They can be made comparable by introducing the interest factor. In the theory of finance, the interest factor is one of the crucial and exclusive concept, known as the time value of money.

Time
value of money means that worth of a rupee received today is different from the
same received in future. The preference for money now as compared to future is
known as time preference of money. The concept is applicable to both
individuals and business houses.

__Reasons of time preference of money__**:**

**1)**

__Risk__:
There is uncertainty about the receipt of money in future.

**2)**

__Preference for present consumption__:
Most of the persons and companies have a preference for present
consumption may be due to urgency of need.

**3)**

__Investment opportunities__:
Most of the persons and companies have preference for present money
because of availabilities of opportunities of investment for earning additional
cash flows.

__Importance of time value of money__**:**

The concept of time value of money helps in arriving at the comparable
value of the different rupee amount arising at different points of time into
equivalent values of a particular point of time, present or future. The cash
flows arising at different points of time can be made comparable by using any
one of the following :

- by compounding the present money to a future date i.e. by finding out
the value of present money.

- by discounting the future money to present date i.e. by finding out
the present value(PV) of future money.

**1)**

__Techniques of compounding__:**i)**

__Future value (FV) of a single cash flow__:
The future value of a single cash flow is defined as :

FV
= PV (1 + r)

^{n}
Where, FV = future value

PV = Present value

r = rate of interest per annum

n = number of years for which compounding is done.

If, any variable i.e. PV, r, n varies, then FV also varies. It is very
tedious to calculate the value of

(1 + r)

^{n }so different combinations are published in the form of tables. These may be referred for computation, otherwise one should use the knowledge of logarithms.**ii)**

__Future value of an annuity__:
An annuity is a series of periodic cash flows, payments or receipts, of
equal amount. The premium payments of a life insurance policy, for instance are
an annuity. In general terms the future value of an annuity is given as :

FVA

_{n}= A * ([(1 + r)^{n }- 1]/r)^{Where,}

FVA

_{n}^{ = Future value of an annuity which has duration of n years. }^{A = Constant periodic flow}

^{r = Interest rate per period }

^{n = Duration of the annuity}

^{Thus, future value of an annuity is dependent on 3 variables, they being, the annual amount, rate of interest and the time period, if any of these variable changes it will change the future value of the annuity. A published table is available for various combination of the rate of interest 'r' and the time period 'n'.}

**2)**

__Techniques of discounting__:**i)**

__Present value of a single cash flow__:
The present value of a single cash flow is given as :

PV
= FV

_{n}(__1__)^{n}`1 + r`

Where,

FV

_{n = }^{Future value n years hence}^{r = rate of interest per annum}

^{n = number of years for which discounting is done.}

^{ From above, it is clear that present value of a future money depends upon 3 variables i.e. FV, the rate of interest and time period. The published tables for various combinations of }

^{ ( }

^{ 1 }^{)}

^{n}

^{ }

^{1 + r}

^{are available.}

**ii)**

__Present value of an annuity__:
Sometimes instead of a single cash flow

**,**cash flows of same amount is received for a number of years. The present value of an annuity may be expressed as below :
PVA

_{n}= A/(1 + r)^{1}+ A/(1 + r)^{2}+ ................ + A/(1 + r)^{n-1}+ A/(1 + r)^{n}
= A [1/(1 + r)

^{1}+ 1/(1 + r)^{2}+ ................ + 1/(1 + r)^{n-1}+ 1/(1 + r)^{n}]
= A [

__(1 + r)__]^{n}- 1
r(1 + r)

^{n}
Where,

PVA

_{n }= Present value of annuity which has duration of n years
A = Constant periodic flow

r = Discount rate.

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