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The Time Value of Money and Net Present Value

The mother of all finance

Here, we are going to start our lessons on “rate of return” concept – cornerstone of finance. Earning interest on money is not difficult if you just simply deposit it to a bank. This hence deduces that earning money today is a valuable deal rather than making the exact same amount on the upcoming year. The concept of this activity is termed as time value of money. Thus, the worth of a $1 in the present is much better than earning the same amount in the upcoming future.

Investors are just a one sided portion of the financial market economy. Investors give out or invest their money at the present market just to make more money in return in the future. Businesses hence make another side of such story. You are hence, directed to the term capital budgeting which is a process that firms undertake to analyze on what must be done with all money that they have – the projects that they must invest in and the ones to pass off. You will further learn the factor that there will be a certain method that you must undertake to make such critical decisions. Firms must translate all the future inflows and outflows that are equivalent to the present values of today’s date. This is then added up with the NPV or net present value. A firm must take only those projects that offer a positive NPV and alternately discard the negative NPVs.

We better get you started as it may sound complex, but with a little practice, it will become super easy.