Every firm, no matter how little or huge, requires financial resources in order to succeed. Every company’s lifeblood is finance. It is vital for the financial manager to make appropriate financial decisions. Included in financial decisions are:
Finance decision: This decision aids a financial manager in determining how to raise funds from various sources. A financial manager can raise funds from a variety of sources. It could be equity, debt, or preference share capital.
Investment decision: After obtaining cash from various sources, it is required to put those funds to use. Various factors must be considered while making an investment decision, including the time value of money, payback period, profit, and rate of return, among others.
Dividend choice: In this decision, the financial management determines how much of the profit should be dispersed and how much should be kept in the business as a reserve for future development.
The term “time value of money” refers to the fact that money invested today has a different value than money invested tomorrow. It might go up or down. It is determined by the nature of the goods in which an investment is made as well as the risk associated in that investment.
For example: assuming a 5% interest rate, $100 invested today will be worth $105 in one year ($100 multiplied by 1.05). Conversely, $100 received one year from now is only worth $95.24 today ($100 divided by 1.05), assuming a 5% interest rate.
Time value of money is important factor while making investment decision .There are various reason for this:
Risk premium: The bigger the risk involved with an investment’s future cash flows, the higher the profit.
Inflation rate: As the rate of inflation rises, the value of money and people’s purchasing power decreases.
Maximizing wealth is something that every company strives towards. The temporal worth of money must be considered while maximizing wealth.
Uncertainty about the future: The future is uncertain. Although no investor can prevent future uncertainty, he or she can lessen it by assessing the future value of an investment using the time value of money method.
Cash flow: To determine cash inflows and outflows, the time value of money must be calculated.