CAT / FIA FFM Syllabus E. Investment Decisions - Concept of time value of money - Notes ^{2 / 3}

The time value of money

is based on the concept that money received now is worth more than the same sum received in one year's time or at another time in the future.

Reasons why a present $1 is worth more than a future $1 can be:

• Uncertainty 

  The business world is full of risk and uncertainty, and although there might be the promise of money to come in the future, it can never be certain that the money will be received until it has actually been paid.

• Inflation 

  Because of inflation it is common sense that $1 now is worth more than $1 in the future.

• Preference

  An individual attaches more weight to current pleasures than to future ones, and would rather have $1 to spend now than $1 in a year's time.

Discounted cash flow (DCF)

is a project appraisal technique that is based on the concept of the time value of money, that $1 earned or spent sooner is worth more than $1 earned or spent later.