2.1. Time Value of Money Flashcards
Cash flows…
Cash flow is the amount of money being transferred into (inflow) or out of (outflow) a firm by implementing a project.
Cash flows allow management to see if a project is value-added and if it contributes to shareholder wealth maximisation.
Time value of money…
Considers today’s value of cash flows that are expected to occur in the future.
Generally, one pound expected in ten years is worth less than one pound received today.
If you deposit (or borrow) money, you should receive (or pay) interest on it.
If you invest your money in an asset, you should expect to be rewarded with a rate of return.
Why money is more valuable today…
Inflation: the loss of purchasing power over time.
Time preference: people prefer to spend today and save for later.
Risk: expected cash flows are risky, as predicted cash flows are not guaranteed.
Opportunity cost: money can be invested to create value. By not investing today, we may lose out on potential returns.
