Explain The Time Value Of Money Smu Assignment Project


Financial Management Unit 10Sikkim Manipal University


generating the management’s expectation on the rate of return will be cleared. Generally internalcapital rationing is used by a firm as a means of financial control.

Self Assessment Questions 1

1. When a firm imposes constraints on the total size of its capital budget, it is known as _____________.2. Internal capital rationing is used by a firm as a ______________________.3. Rigidities that affect the free flow of capital between firms cause _________________.4. Inability of a firm to satisfy the regularity norms for issue of equity shares for tapping the marketfor funds causes __________________.


Steps involved in Capital Rationing

Steps involved in Capital Rationing are:1. Ranking of different investment proposals2. Selection of the most profitable investment proposal

Ranking of different investment proposals

The various investment proposals should be ranked on the basis of their profitability. Ranking isdone on the basis of NPV, Profitability index or IRR in the descending order.

Profitability index as the basis of Capital Rationing

The following details are available:

Cash InflowsProject Initial Cash outlay Year 1 Year 2 Year 3

A 1,00,000 60,000 50,000 40,000B 50,000 20,000 40,000 20,000C 50,000 20,000 30,000 30,000Cost of Capital is 15 %Computation of NPV

 Year Cash in flows PV factor at 15% PV of Cash inflows

1 60,000 0.870 52,2002 50,000 0.756 37,8003 40,000 0.658 26,320


Excel BooksExcel Books

3 ±3


Copyright © 2006, Dr Sudhindra Bhat

Time Value of Money

Meaning of Time Value of Money

µMoney has time value´. i.e, the value of money changes over a period of time The valueof a rupee received today is different from the value of a rupee to be received after a year. A rupee today has value than a rupee after a year.

Factors contributing to the Time Value of Money


oney has a time value because of the following reasons.

individuals generally prefer current consumption to future consumption

an investor can profitably employ a rupee received today to give him a higher value tobe received tomorrow or after a certain period.

In an inflationary economy the money received today has more purchasing power than money to be received in future.

µA bird in hand is worth two in the bush¶ : This statement implies that people consider a rupee today worth more than a rupee in the future, say, after a year. This is becauseof the uncertainty connected with the future.


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