Time Value of moneyValue of money keeps on changing with the interest rates prevailing in the market. The value of $1 todayis NOT equal to $1 afterone year.The value of money changes from the current year to the base year or from current year to the next year.And this can be measured by interest rate as interest rate is a bridge that connects two time periods. It ismeasured by two techniques:1. Compounding (Future Value)Compounding techniques will be applied whenever we deposit or invest the money for the future years.The example are fixed deposits, insurance plans, mutual funds, retirement plans, SIP, RD (recurringdeposits), pension plans. In all such products, we will apply the power of compounding to calculate thefuture sums of money invested in the business).Note:A Systematic Investment Plan or SIP is a smart and hassle free mode for investing money inmutual funds. SIP allows you to invest a certain pre-determined amount at a regular interval (weekly,monthly, quarterly, etc.)2. Discounting (Present Value)In the case of discounting, we want to calculate the present value where future is given to us so in allinvestment projects where we want to know the present value of the future sum of money, we will beusing the discounting technique to calculate the present value in order to compare the outflows with thefuture inflows which is known as NPV (Net Present Value).E.g.: All capex, project appraisals, equity valuation, bonds valuations, loan EMIs (Equated MonthlyInstalment), debt repayment schedule. In all such products we will apply the discounting techniquebecause we are in a position to estimate the present value of the expected future cash flows.Stock market is known for discounting their future cash flows and whenever we invest in stocks, we areanticipating certain events which are going to happen based on which we estimate the target price of thestock.Example case:-JP Morgan says Microsoft share price will hit $40 in a year, you buy Microsoft share now at $34(discounted).-Nakheel anticipates future inflows, which will be worth much more than current outflows. That’swhy they invest in development and construction projects now. The difference between FV andPV is their NPV.Present Values Formula :FV = PV(1 + r)tRearrange to solve PV :PV=FV(1+r)tNPV and IRREverything you do, you must calculate NPV.NPV = -initial investment + future inflows

PV+++++If NPV is positive, then investIf NPV is negative, don’t investExample in corporates where you apply PV technique:-BOO-BOT-BOOT-EPC-L&PThey are all doing PV techniquediscounting the future, today.Note : Build–operate–transfer (BOT) or build–own–operate–transfer (BOOT) is a form of projectfinancing, wherein a private entity receives a concession from the private or public sector to finance,design, construct, own, and operate a facility stated in the concession contract.The Net Present Value shows the difference between the project’s financial benefits and costs. NPV is

Upload your study docs or become a

Course Hero member to access this document

Upload your study docs or become a

Course Hero member to access this document

End of preview. Want to read all 8 pages?

Upload your study docs or become a

Course Hero member to access this document