Time value of money shows the relation of value of money with time. Time value of money is also value of interest which we have earned for giving money to other for specific period.

**Time Value Of Money**

**1 Concept**

**Time value of money **shows the relation of**
value of money **with** time**.** Time value of money **is also value of** **interest** **which we have
earned for giving money to other for specific** **period. Value of Rs. 1 which you have today is more valuable than
what Rs. 1 you will receive after one year because you can invest today receive
Rs. 1 in any scheme and you can earn minimum interest on it. It means today
received money is important than tomorrow receivable money. Interest rate is the cost of borrowing money as a yearly
percentage. For investors, interest rate is the
rate earned on an investment as a yearly percentage.

Time value
of money results from the concept of interest. So it now time to discuss
Interest.

**1. Simple Interest**

It may be
defined as Interest that is calculated as a simple percentage of the original
principal amount. The formula for calculating simple interest is

SI = P0
(i)(n)

Future value of an account at the end of n period
FVn = P0+ SI = P0 + P0(i)(n)

**2 Compound Interest**

If
interest is calculated on original principal amount it is simple interest. When
interest is calculated on total of previously earned interest and the original
principal it compound interest. Naturally, the amount calculated on the basis
of compound interest rate is higher than when calculated with the simple rate.

FV _{n}
= P_{o} (1+ i) ^{n}

Where,

i = Annual rate of interest / Number of
payment periods per year

= r/k

So, FV _{n}
= P_{0} (1 + r/k)^{n}

When
compounding is done k times a year at an annual interest rate r.

Or

FV_{n}
= P_{o} (i + FVIF) _{in}

Where,

**Effective Rate of Interest**

It is the
actual equivalent annual rate of interest at which an investment grows in value
when interest is credited more often than once a year. If interest is paid m
times in a year it can be found by calculating:

Ei = (1+
i/m) ^{m} -1

**3 Present Value**

―Present
Value‖ is the current value of a ―Future Amount‖. It can also be defined as the
amount to be invested today (Present Value) at a given rate over specified
period to equal the ―Future Amount‖.

The
present value of a sum of money to be received at a future date is determined
by discounting the future value at the interest rate that the money could earn
over the period. This process is known as **Discounting**.
The present value interest factor declines as the interest rate rises and as
the length of time increases.

P_{o =}
FV_{n} /(1+ i) ^{n}

P_{o =}
FV_{n} (1+ i) -^{n}

Where,

FVn = Future value n years hence

I = Rate of interest per annum

n = Number of years for which discounting
is done.

**B. Discount (or) present value technique: -**

= _{(1+ )}

Present
value V_{o} = Future value (V_{n}) x DF_{in}

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Business Science : Financial Management : Foundations of Finance : Time Value of Money |

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