Time Value of Money

Time Value of money or TVM arises from the fact that the value of money is time dependent. The Value of money received today is different from the value of money received after some time. This principle is based on the following reasons:-

Inflation-Under Inflationary conditions the value of money, expressed in terms of
purchasing power over goods and services, generally declines giving
rise to the principle of Time Value of Money.

Risk-$ 1 received today is certain whereas $ 1 receivable tomorrow is less certain."The bird in the hand" principle is extremely important at the time of investment appraisal again giving rise to the principle of Time Value of Money.

Consumption Preferences -There is a strong preference for the immediate rather than delayed consumption. The promise of a bigger pizza next week counts less for a starving man.

Investment Opportunities-Money like any other desirable commodity has a price, given the choice of $ 100 now or the same amount in one year, it is always preferable to take the $ 100 now because it could be invested over the next year at say 10% interest rate to produce $110 at the end of the year.

Time Value of Money is one of the most important concepts in finance. A deep understanding of this is required to lay the foundations of a sound degree in finance.

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