Question

It has been stated that ‘Time has value.’ What does this mean when we are evaluating a series of cash flows?

Answer 1

Evaluating a series of cash flows means discounting the future cash flows to present value. The formula to discount the future cash flows is:
Present value of future cash flow=(Cash flow in year n)/(1+required rate)^n
Here, n is the number of years.

Time value of money equation is: Future value=Present Value*(1+required rate)^(Number of years)
=>Present Value=Future value/(1+required rate)^n

In a series of cash flows, with increase in the number of years, the discounted value of the cash flows to the present value will decrease.

For example, suppose the cash flow is say $1000 for 5 years with required (or discount) rate of 10%. After discounting the values to the present value we will have:

Year 0:1000/(1+10%)^1=1000/1.1=909.0909091
Year 1:1000/(1+10%)^2=1000/1.21=826.446281
Year 2:1000/(1+10%)^3=1000/1.331=751.3148009
Year 3:1000/(1+10%)^4=1000/1.4641=683.0134554
Year 4:1000/(1+10%)^5=1000/1.61051=620.9213231
Year 5:1000/(1+10%)^6=1000/1.771561=564.4739301

In the example, we can clearly see that the present value of same amount of cash flow decreases as time period increases. So, we can say that money today worth more than the same amount (we receive) in future and this is called time value of money.
So, if higher amount cash flows come earlier in a series of cash flows, then the present value of the total cash flows will increase.
If the present value of the future cash flows increases, the value of the firm also increase.