Time Value of Money and Financial Planning

Time Value of Money and Financial Planning

The whole financial management is based on the principle that a penny received today is worth much more than a penny received after a year. This is also known as time value of money which is widely used in order to assess the potential of future investments to be made by any organization. The basis of all the current investment decisions is made after considering the estimated future profitability of the investment. This analysis is highly important in order to understand whether the investment will be able to provide the required return to the investors or not and the required return is within the time estimated by the financial managers. Before making an investment, its desirability is always analysed which includes considering whether the life span of the project in enough to generate good returns from the project and this is performed by analysing its cash flows using time value of money.

Financial managers use a variety of concept for analysing an investment that includes NPV analysis, IRR analysis, payback period and average return on investment. Due to the fact that the later two mentioned does not takes into account the time value of money they donot give an accurate account of any investment decision.

Time value of money also takes into account the element of compounding the amounts while calculating the time value of money. This compounding refers to the fact that the interest can be earned on interest as well. Hence the time value of money takes these factors into consideration while analysing different cash flow streams. The other factors that take into account the consideration of time value of money while making huge investment decisions includes the following:

* As finalising any investment plan has its own future uncertainties regarding the cash that the project would generate despite the risk and for that purpose a time value of money is taken into account which...