Concept of Time Value of Money

Learning Outcomes
⮚ Concept of Time Value of Money
⮚ Techniques of Time Value of Money
⮚ Effective Rate of Interest
⮚ Annuity Concept
⮚ Concept of Perpetuity
⮚ Loan Amortization
Abstract
The time value of money is the concept that shows the importance of money currently more
than in future. To identify the time value of money we have to follow two techniques. They
are the Compounding Technique (Future Value Technique) and the Discounting Technique
(Present Value Technique). In future value techniques we move the cash flows forward in
time. It is called compounding when interest is earned on interest. In present value technique,
we move the cash flows back in time. It is called as the process of moving cash flows back in
time is called discounting when interest is earned on interest. Then we consider the Annuity
concept. An annuity is a series of fixed sums of payment made at equal intervals. According
to the time that the cash flow occurs we identified two concepts as ordinary annuity and
annuity due. There are four formulas to determine the present values and the future values of
a cash flow with regard to concepts, ordinary annuity and annuity due. After we consider the
effective rate of interest and perpetuities concept. Finally, we get an understanding about the
loan amortization concept and amortization schedule steps.
Time Value of Money

The time value of money is the concept that money you have now is worth more than the
identical sum in the future due to its potential earning capacity. It means money has more
value and utility to the beneficiary than receiving in the future due to the opportunity costs
associated with the wait. So, we can identify four main reasons for the time value of money.
● Risk & Uncertainty
● Current Consumption
● Inflation
● Investment Opportunities
Techniques of Time Value of Money
In order to have logical and meaningful comparisons between cash flows that result in
different time periods it is necessary to convert the sums of money to a common point in
time. There are two approaches for adjusting the time value of money.
1. Compounding Techniques / Future Value Techniques
FV = PV (1+r) n
Interest Rate can be compounding daily, monthly, quarterly and half year. Then, the
compounding technique identified below.
FV = PV (1+ r/m) mt
2. Discounting / Present Value Techniques
PV = FV / (1+r) n
Effective Rate of Interest