Question 1 (b)

The time value of money and the factors that affect it

7 marks

Time to write
About 14 minutes

From an older CBCS paper

Question

Question 1 (b) · 7 marks

Explain the Concept of the Time Value of Money. What factors affect the Time Value of Money?

Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.

Before you write

Read off the question and its marks

14 minfor 7 marks

Read from the question

  • Explain…What…?Two asks in one question: answer both.

Write it in this order

  1. Read; underline the asks; jot your points 1 min
  2. 1 Concept of the time value of money 2 marks 2 min
  3. 2 Factors that give money time value 3 marks 6 min
  4. 3 Compounding and discounting 2 marks 4 min
  5. Check: every ask answered, key terms underlined 1 min

Easy marks

  • Concept of the time value of money (step 1, 2 marks): a clear definition and a line on what it covers. It opens the answer, so it takes a minute or two.

Short on time? Keep step 1 short. Trim steps 2 and 3 evenly rather than skip one: each is capped at its own marks.

Try it first. About 14 minutes for 7 marks. Write it out, then open the solution.

Solution

Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.

Why it matters. Financial decisions compare money paid or received at different times. ₹1,000 now is worth more than ₹1,000 after a year: we part with money now only for something more later, and that extra is interest, the time value of money. Money has time value because of the preference for present consumption, the opportunity to invest present cash, the uncertainty of the future (the most important reason) and inflation. Adding up cash flows of different years as if they were equal would overvalue distant benefits and lead to wrong investment, financing and dividend decisions.

How time is adjusted. Cash flows of different dates are brought to a common date at an interest (discount) rate:

  1. Compounding (future value): interest earned becomes part of the principal at the end of each period, so a sum grows to P(1 + i)ⁿ after n periods; all flows are carried forward to a future date.
  2. Discounting (present value): the exact opposite: a future sum is divided by (1 + i)ⁿ to find its value today, and all flows are brought back to the present. Capital budgeting uses this, through NPV, IRR and the profitability index.

Tables of compound and present-value factors (and annuity factors for equal annual amounts) make the adjustment simple.

Where the 7 marks sit

#ComponentMarks
1Concept of the time value of money2
2Factors that give money time value3
3Compounding and discounting2
Total7
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