Time Value of Money

Time Value of Money

• Would you prefer to have Rs. 100,000 now or Rs. 100,000, 10 years from now?
• Of course, we would all prefer the money now! This illustrates that there is an inherent
monetary value attached to time.
• Time value of money means that the value of money is different in different time
periods. The value of money received today is more than the value of same amount
receivable at some other time in future.
• The difference in the value of money today and tomorrow is referred as time value of
money.
• Therefore, given a choice of receiving a sum of money today or in the future, a rational
person will always choose to receive the money now as it has more value today than in
the future.
Reasons to the individual’s time preference for money

• Investment Opportunities
• Risk (Future is uncertain and risky)
• Personal Consumption Preference
• Inflation (Purchasing power)
 Techniques of Time Value of Money

Two most common methods of adjusting cash flows for time value of money:
• Compounding—the process of calculating future values of cash flows and
• Discounting—the process of calculating present values of cash flows.
Valuation concepts

Interest are of two types:

• Simple Interest
• Compound Interest
 Simple Interest

Simple Interest = P0(I)(n)

Where:
P0 = Principle amount at year 0
I = Interest rate per annum
N = number of years for which interest is calculated

Formula for calculating Future value

FVn= P0 + P0(I)(n)
Where:
FVn = Future value at the end of “n” years.
Examples:
Q.1.What is the simple interest and total amount received of Rs. 8,000 for 4 years at
12% p.a.
(3,840 and 11,840)

Q.2.Mohan deposited Rs. 10,000 in a savings bank account today at a 4% simple

interest for a period of 5 years. What is his accumulated interest?
( 2000)
Q.3. At what rate of percentage will Rs. 26,435 amount to Rs. 31,722 in 4 years with a
simple interest rate?
(5%)
Q.4. Krishna’s annual savings are Rs 1,000, which is invested in a bank saving
account that pays a 5% simple interest. Krishna wants to know his total future value at
the end of the 8th year.
(1400)
 Compound Interest

Compound or Future Value of Single Amount

CVn or FVn = Po(1+I)^n

Or = Po×CVIFn.i
Where:
 CVn or FVn =Compound or Future value at the end of n years
 Po=Principle amount at year 0
 I= Interest rate per annum
 n=number of years for which compounding is done
 CVIF= Compound Value Interest Factor
• Q.5 Suppose you have Rs 10,00,000 today and you deposit it with a
financial institute, which pay 8% compound interest for a period of 5
years. How much deposit would grow?
(14,69,328)
• Q.6 Mr Dhruv deposited Rs 50,000 in a Bank for 3 years at 9% per
annum. How much amount would he get at the end of 3 years ?
(64,751)
• Q.7 Find out compounded interest on Rs. 6,000 for 3 years at 9%
compounded annually.
(1,770)
• When interest is payable half-yearly
CVn = Po (1 + i/2 )^2n
• When interest is payable quarterly
CVn= Po(1+i/4)^4n
• When interest is payable monthly
CVn = Po (1+i/12)^12n
• When interest is payable daily
CVn= Po(1+i/365)^365n
• Q.8 Find out compounded interest on Rs. 40,000 for 5 years at 10%
compounded annually.
(64420)
• Q.9 How much does a deposit of Rs.40,000 grow to at the end of 10
years at the rate of 6% interest and compounding is done semi-
annually. Calculate the amount at the end of 10 years.
(72,244)
• Q.10 Suppose that a firm deposits Rs. 50 lakh at the end of year for 4
year at the rate of 8% interest and compounding is done on quarterly
basis. What is the compound value at the end of 4 th year?
(68,63,928)
Compound Value when Multiple series of cash inflow
b. If cash inflow is even (Annuity)

• Annuity is a series of even cash flows for a specified duration. It involves a

regular cash outflow or inflow. For e.g. recurring deposit, systematic
investment plan, life insurance premium etc.

• If cash flows happen at the beginning of the year, it is called annuity due,
whereas when the cash flows happen at the end it is called as a regular or
ordinary or deferred annuity.
• Q.11.Mr Y deposits 5000 at the end of each year at 8% per year. What
amount will he receive at the end of 6 years?
(36679)
• Q.12.What will a deposit of 4,500 at 10% compounded semiannually
be worth if left in the bank for six years?
(8081)
• Q.13.Given an annual opportunity cost of 10%, what is the future
value of Rs.1,000 ordinary annuity for 10 years?
(15937)
• Q.14.How long does it take for Rs 856 to grow into Rs 1,122 at an
annual interest rate of 7%? If interested compounded annualy.
(4 years)
• Q.15.How much will an ordinary annuity of Rs 650 per year be worth in
eight years at an annual interest rate of 6 percent?
(6433)
• Q.16.What annual interest rate would you need in order to have an ordinary
annuity of Rs 7,500 per year accumulate to Rs 2,79,600 in 15 years?
(12%)
• Q.17.What annual interest rate is implied if you lend someone Rs 1,850
and are repaid Rs 2,078.66 in two years?
(6%)
• Q.18.Mr A deposits at the end of each year Rs.2,000,3,000,4,000,5,000 and
6,000 for years 1 to 5 respectively. He wants to know his series of deposits
value at the end of 5 years with 6% rate of compound interest.
(21,893)
 Rule of 72

Rule of 72 is a shortcut to estimate the number of years required to

double your investment at a given annual rate of return.
• Q.19. If you deposit Rs 500 today at 10% rate of interest, in how many
years will this amount double?
(7.25 years)
• Q.20.How long will it take to double your money if it grows at 12%
annually?
(6 years)
• Q.21. Suppose A invest Rs 100000 and he wants to double the amount
at 8 % per annum. How much time require to double the amount ?
(9 years)
Present Value
Q.22An investors wants to find the present value of Rs.40000 received
after 3 years. His interest rate is 10%.
(30052)
Q.23 What is the present value of Rs. 2,67,600 which will received after
5 years at 6% rate of interest?
(1,99,977)
Q.24 Calculate the present value of each of the following cash flows
using a discount rate of 14%
a. Rs 2,000 cash outflow immediately Rs.2000
b. Rs 6,000 cash inflow one year from now Rs. 5263
c. Rs.6,000 cash inflow two years from now Rs.4617
d. Rs 7,000 cash inflow four years from now Rs. 4144.7
b. Present value of a series of cash flows
1.Present value of uneven cash flows:

2. Present Value of Even Cash Inflow:

Q.25 Mr. Y has to receive Rs. 500 at the beginning of each year for 4 years.
Calculate present value of annuity due assuming 10% rate of interest.
(1743.5)

Q.26 Mr. X has to receive Rs. 4000 at the end of each year for 6 years.
Calculate present value of ordinary annuity assuming 10% rate of interest.
(17,421)
 Meaning of Perpetuity
• An indefinite series of payment of equal amounts at regular intervals
on a fixed date is known as Perpetuity.

• The word ‘Perpetuity’ is a combination of two terms perpetual annuity,

i.e. a form of annuity which goes on forever and therefore its future
value cannot be calculated. Hence, it is a continuous stream of
consistent cash flows over the years.
 Key Differences Between Annuity and Perpetuity

• A series of continuous cash flows of an equal amount over a limited

period is known as Annuity. Perpetuity is a type of annuity which
continues forever.
• The annuity is for a fixed period, but Perpetuity is everlasting.
• Future Value of annuity can be easily calculated which is not possible
in case of Perpetuity.
• Perpetuity is an annuity, but an annuity is not perpetuity.
 Present Value of Perpetuity

Q27 Mr. A an investor expects a perpetual amount of Rs 1000 annually

from his investment. What is his present value of perpetuity if the interest
rate is 8%?
(12,500)
 Effective Rate of Interest

Q.28 Mr. X deposited Rs 1,000 in a bank at 10% of rate of interest with

quarterly compounding . He wants to know the effective rate of interest.
(10.38%)
Application of Time Value of Money

• Sinking Fund
• Loan Amortization
• Equated Monthly Investment
• CAGR
 Meaning of Sinking Fund

• A sinking fund is an account that is used to deposit and save money to

repay a debt or replace a wasting asset in the future.
• In other words, it’s like a savings account that you deposit money in
regularly and can only be used for a set purpose.

Where:
AP = Annual Payment
FVAn = Future value after n number of years
I= Interest rate
Q.29 A financial manager of a company wants to pay a debt of
Rs 2,00,000 at the end of 5 years . He requests to find out the annual
payment required . If his savings earn an interest rate of 10% per annum.
(32,759)

Q.30 Finance Manager of a company wants to buy an assets costing

Rs. 1,00,000 at the end of 10 years. He required to find out the annual
payment required , if the saving earns an interest of 12% per annum.
(5,698)
 Meaning of Loan Amortisation
• Loan is an amount raised from outsiders at an interest and repayable at
a specified period (Lumpsum or Installments).
• Payment of loan is known as amortization.
• Financial manager may take loan and he/she may be interested to
know the amount of equal instalment to be paid every year to repay
the complete loan.

OR
Where:
LI= Loan instalment, P= Loan amount, I = Interest rate
N= Loan repayment period
Q.31 A company has raised a loan of Rs 50 lakh from an industrial finance bank at
9% per annum. The amount has to be paid back in 5 equal yearly instalments.
Calculate the instalment amount.
(12,85,347 or 12,84,879)

Q.32 A firm takes a loan of Rs 25,00,000. If the compounding rate of interest is

12%. Find out the amount of each installment if it is repaid in 5 equal installments.
(6,93,481)
 Equated Monthly Instalments (EMI)

Where:
P= Loan amount
I= Interest rate per month
n=Loan period in months

Q.33 Assuming a loan as Rs.1,00,000, at 12% repay in 1 years . Calculate

EMI ?
(8874)
Compound Annual Growth Rate
Q.34 From the following dividend data of a company, calculate
compound growth rate of growth for period (2012-2017).
Year 2012 2013 2014 2015 2016 2017
DPS 21 22 25 26 28 31

(gr = 8%)