In order to achieve the objective of the maximization of the wealth of the shareholders, the finance manager has to take various decisions.
These decision i.e., the investment decision and the didvidend decision involve evaluation of various alternative series of cash flows occurring over time.
For example, a finance manager is evaluation a proposal of replacing an existing machine by a new machine by a new machinefor which 3 options are available i.e. machine A, machine B and machine C. These 3 machines may differ from one another in respect of cost, life, scrap value, annual benefits, repairs, maintanace, etc.
The financial manager while making comparative study of these options may find that the cash flows (in the form of cost, benefits, repairs, etc.) are different not only in quantum but also with respect to timing of their occurrences.
One machine may give lower but early returns, while the other may give higher returns but at a later stage. One machine may be less costly while other may be costlier.
The series of cash inflows and cash outflows arising out of a decision are not comparable. The simple reason being that one rupee of time period I is not comparable with one repee of some other time period.
However, one rupee od different time period can be made comparable by introducing the interest factor. This interest factor is one of the crucial and exclusive concept of the theory of finance.
This concept is also know as the concept of time value (TVM). In Higlights I, the time value of money has been referred to as an axiom of finance management.
Every individual or a firm definitely has a prefrence to receive money today against the money receivable tomorrow.
Reinvestment opportunities : Individual as well the firm has prefrence for present money because they have reinvestment oppertunities available to them.
If they have got the money because, they can invest this money to get further returns on this This opportunity to get returns will not be available if the money is not invested now.
The existence of reinvestment opportunities and the urge to return by investing this current money seem to be the ovious reason for the time prefrence the money. This expected return which which can be earnedby investing the present money is in fact the TVM.