Time value of Money

• A popular English proverb "a bird in hand is

worth two in the bush".
• present values are better than the same
values in the future
• “Earlier returns are better than later”.
• If a person wanted to have money at present
than future, then it is called time value of
money.
• It is because of (i) uncertainty (ii) present
consumption (iii) investment opportunity.
 Discounting
• The process of finding the present worth of a
future value is called discounting.
• The interest rate assumed for discounting is the
discount rate.
• the value of the present investment on future
date is called compounding or future value of
money whereas in discounting all cash flows can
be brought to today’s value, instead of
compounding n
to future date. Mathematically, P =
M ×(1/(1+r) )
Where, P = present value of money, M = quantity
of money at present
 n
• discount factor = (1+r)
• The most common means of doing this
discounting process is to subtract year by year
and the costs from the benefits to arrive at the
incremental net benefit stream that is cash flow.
• This approach will give one of three discounted
cash flow measures of project worth:
• NPW,
• IRR or NBIR (Net Benefit Investment Ratio).
• Another discounted measure of project worth is
to find the present worth of the cost and benefit
streams separately and to obtain benefit cost
ratio.
• Discounting is a process of converting a single
future payment or series of future payments
to the equivalent present worth.
• For example, one year deferred payment of
Rs. 100 is less than Rs. 100 at present. The
present value and one year later value of
Rs.100 depends on interest rate. Thus, as the
longer time of deferred payment present
value of money will be less and less.
• . The computation of discount factor, DF (r/n):
• DF (r/n) = 1/1+(r/100)n
• Where, n = number of years hence that the
payment will occur.
• r = discount rate (%).
• 2. Multiply the discount factor by the
payment amount to get the present worth:
• PW = payment  DF (r/n), P=present worth,
 Purpose

• Discounting provides a basis for analyzing and

comparing future streams of costs and
benefits by reducing them to their equivalent
present worth.
 Uses
• Future payments, either single, a uniform series,
or an irregular series can be converted to thir
present worth by using discount factors
computed from an appropriate discount rate.
• The difference between payments made in the
future can be translated into a constant discount
rate to measure the preference for present as
opposed to future benefits.
• Discounting permits inclusion of time preference
in analyzing the net value of a single project, and
in comparing two or more projects with dissimilar
time stream of costs and benefits.
 Advantage

• Discounting provides a logical basis for comparing

payments at various times. It facilitates the
valuation of single project or a comparison
between the projects.
• Discounting puts more value on near term than
on distant payments. Since more distant forecasts
are generally less reliable than short term
forecasts, discounting increases the degree of
confidence that the analyst may have in his
valuation.
A hypothetical discount table of five years at 8% interest rate.
Note: the more than 15% interest rate and 20 years period will
not be considered in calculation.
Calendar Amount One plus Amount at
year at end of interest beginning of
year rate year

t5 2013 1,200  1.08  1,111

t4 2012 1,111  1.08  1,029

t3 2011 1,029  1.08  953

t2 2010 953  1.08  882

t1 2009 882  1.08  817

t0 2008 817  1.08 