What is time value of money? Compare the main features of payback, net present value and internal rate of return methods of evaluation.

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written 5.6 years ago by

teamques10 ★ 68k

Money available at present time is worth more than sum in future due to its potential earning capacity.

Present money can earn interest with interest rate “i”.

There are several reasons for it.

Everyone prefers to receive money today rather than the same amount of money in future due to its potential to grow in value over a given period of time.
Money today has greater purchasing power than future due to inflation rate.
Capital can be employed productively to generate positive returns

Formula for Time value of money

$\mathbf{F V}=\mathbf{P V} \mathbf{x}[1+(\mathbf{i} / \mathbf{n})]^{(n \times 1)}$

Where,

$FV$ = Future value of money

$\mathrm{PV}=$ Present value of money

$\mathrm{i}=$ interest rate

$\mathrm{n}=$ number of compounding periods per year

$\mathrm{t}=$ number of years

Comparison of Payback, Net Present Value and Intermal Rate of Return

Sr. No.	Payback	Net Present Value	Internal Rate of Return
1	Calculate in terms of time required for the return to repay the initial investment	NPV is calculated in terms of rupee value	IRR calculates in terms of percentage rate of return at which cash flows
2	Focuses on how quickly money can be returned from an investment	Focuses on project surpluses	focused on the breakeven cash flow level of a project
3	Simplest method	Heavily used method	Used for Capital budgeting process

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