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Q2. Briefly discuss the Time Value of Money concept?

Ans:

• Price/value today of cash flows (whether the cash flow is a payment to be made or income to be received) that occur in the future is determined by the time value of money (TVM)
• TVM is based on belief that people prefer to consume goods today rather than wait to consume the same goods tomorrow
• Dollar someone has today can be spent for consumption or loaned to earn interest
• Dollar loaned earns interest that increases wealth and the ability to consume

• Apple we can have today is more valuable to us than an apple we can have in one year.
• Money has a time value because buying an apple today is more important than buying an apple in one year

• The rate of interest determines the trade-off between consumption today and saving (investing)
• Timelines are an effective way to visualize cash flows
• Present cash outflows as negative values
• Present cash inflows as positive values
• Cash-flows are evaluated based on future value or present value
• Future value measures what cash-flows are worth after a certain amount of time has passed
• Present value measures what future cash-flows are worth before a certain amount of time has passed
• Compounding is the process of increasing cash-flows to a future value
• Discounting is the process of reducing future cash-flows to a present value