Time Value of Money
A rupee today beats a rupee next year. The idea every valuation is built on.
₹100 in your hand today is worth more than ₹100 a year from now — because today’s ₹100 can be invested to become more, and because the futureA binding agreement to buy or sell at a set price on a future date. is uncertain. This simple truth, the “time value of money,” underpins all of valuationEstimating what an asset is worth..
Present value = Future amount ÷ (1 + r)^n
r = the rate you could earn elsewhere (discount rate), n = years away. Future money is “discounted” back to today.
ExampleAt a 10% discount rate, ₹110 received in one year is worth ₹100 today (110 ÷ 1.10). ₹100 received in 10 years is worth only ~₹39 today. The further out the cash, the less it’s worth now.
This is the hinge of the whole valuationEstimating what an asset is worth. module: because futureA binding agreement to buy or sell at a set price on a future date. rupees are worth less than present ones, a business is worth the sum of all its futureA binding agreement to buy or sell at a set price on a future date. cash — each rupee shrunk according to how far away it is. Grasp “future money is discounted to today” and discounting (next lesson) becomes obvious.
Key takeawayA rupee today beats a rupee later; futureA binding agreement to buy or sell at a set price on a future date. cash is worth less now and must be “discounted” back to a present value — the foundation of valuationEstimating what an asset is worth..
FAQs
What is the discount rate?
The annual rate used to shrink future cash to today’s value — roughly the return you could earn on a comparable-risk alternative. A higher discount rate (more risk or higher rates) makes future cash worth less today, lowering valuations.