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Financial Management UNIT-1
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Financial Management UNIT-1
Lets start boiling water on our gas stove and getting our notes within minutesπ
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To get completely into the syllabus of this subject Financial Management lovably called as just FM, please come here ππ
The central Idea behind the "Theory of time value of money" is the fact that the money received today is worth more than the same amount of money at any future date.
To understand it clearly, let's say that it simply means that "one rupee today is more than the same one rupee tomorrow".
When this concept is preferred for present money against the future money, then it is termed as time preference for money.
The difference between the value of money at present date and the value of same money at future date is termed as "time value of money"
Need/Reasons for time value of money
1. Risk and uncertainty
Cash outflow is always certain but cash inflow is always doubted and risky and hence, time value of money is preferred.
2. Preference for consumption
Goods and services consumed by the consumer are usually thier urgent and present requirements. Hence, they prefer to have money now to consume now.
3. Investment opportunities
A rupee invested today will give higher level of value in the future by considering time value of money.
4. Inflationary economy
The main reason behind considering the concept of time value of money is the inflationary behaviour of economy, as the purchasing power of same amount of money is decreasing year by year.
Simple interest is the interest paid or computed only on the original amount (principal amt) of a loan or investment.
Compound interest is the interest calculated on the initial principle amount as well as accumulated interest on that amount. This is why it is also known as "interest on interest"
NOTE : The concept of compound interest makes a loan or deposit grow at a faster rate than that of simple interest.
It is defined as the process of determining the present value of a payment or stream of payments which is likely to be the used in the future time.
It is just the opposite of compounding technique.
RELATION OF PV to OTHER FACTORS:
γγPV is positively related to FV which means in order to get higher future value, higher investment should be made today (which means higher present value).
γγPV is inversely related to interest rate(r) which means higher the interest rate, lower will be the present value requirement because money will grow quickly and vice versa.
γγPV is inversely related to time period(n) because longer the time period lower the present value will be required as money will grow more in longer time period and vice versa.
1. Formula for finding the present value of single cash flow is :
2. Present value of uneven cash flow streams can be calculated by adding up all the different cash flows in the streams together as we do in the calculation of finding future value of an even cash flows.
3. Present value of annuity / series of equal cash flows is calculated by the following formula :
βPresent value of growing annuity is calculated by the following formula:
βWhere everything has same meaning as the formula of future value growing annuity Only CF1 here means cash flow at the end of period 1.
4. Present value of perpetuity
Annuity with no fixed time period is known as perpetuity.
The formula to calculate present value of perpetuity:
βGrowing perpetutity is a type of annuity which increases the payment gradually over an indefinite period of time.
Requirement of sinking funds (Sinking funds are defined as the fund created by any business entity by setting aside a fixed amount of money for a particular time period which can help the business in the repayment of long term loans or can be helpful in paying for unforseen capital expenditure.)
Capital recovery(The concept of TVM can be used to find out the annual amount required to be paid for recovering the invested capital in a business.)
This concept states that there are some borrowers who are willing to repay the loan amount but after a definite time period.
For example, if a borrower has taken loan of 10000 and will start paying the interest on it after 6 months, then the lender will calculate the time value of those 6 months and then he will implement the interest on the loan taken and the borrower will have to pay the total interest of those 6 months.
To understand it clearly, it simply says that if the borrower is willing to repay loan after some amount of time, then the lender will calculate the time value of money from the day of lending and will then apply the interest on the loan amount.
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