Time is money!

Time is money

Calculation of the time value of money is very important as it implies that the money you have today in your hand is worth more than the money you will have in the future. in other words, the value of money received today is more than the same value of money receivable after 5 years. as the year increased the value of money decreased.

sooner the money received is better.

To understand this concept well we need to learn about time preference for money and that we will understand with the help of an example:- Mr. X is going to receive 20000 Rs and he has 2 choices - 

He can receive that amount immediately 

         or 

After one year

Mr. X chooses the amount to take immediately is called time preference for money and suppose if he chose it to take after 1 year than 1 year of interest would be paid to him and that interest paid is expressed as time preference of money.

Normally people prefer to take their money immediately due to the following reasons:

Uncertainty of loss

Present needs

Investment opportunities present today

TECHNIQUES OF TIME VALUE OF MONEY

1. Compounding Techniques
2. Present value Techniques or Discounting Techniques

Compounding Techniques: To know the future value of your present money or amount is called compounding.

Know compounded value through a lumpsum method

Mr. X deposited 20000 rs for 3 years at 10 % interest rate, what is the compounded value of his deposits?

Formula:   FV=P(1+I)^n where FV= future value, P = principal , I = interest rate/100 , n = number of years

FV= 20000(1+0.10)^3

FV= 20000(1.10)^3

FV= 20000(1.331)

FV= 26,620

Nowadays there are so many sites which automatically show you the time value of money.

The next thing which we are interested in know the doubling period of your money that we can calculate from tumb rule 72. according to this rule dividing 72 by the current interest rate will be your doubling period of investment.

If the rate of interest is 12% then the doubling period = 72/12 = 6 years

Compounded value of an annuity:

Annuity means a series of equal investments made every year for a particular period of time.

when the cash flows occur at the end of each period is called regular annuity and when the cash flows occur at the beginning of every year then it is called an annuity due.

Mr. X deposited rs 20,000 at the beginning of each year for 3 years at 12 %, what is the maturity value after 4 years.

Formula:   FV=A(1+I)^n+A(1+I)^n-1+...............+A(1+I) where FV= future value, A = Annuity , I = interest rate/100 , n = number of years

FV= 20000(1+0.12)^3+20000(1+0.12)^2+20000(1+0.12)

      = 28098+25080+22400

      = 75578

so this is how we can know how much benefit we are getting after a certain period of time from our investment and that will help while deciding the mode of investment.