Time Value of Money Questions

FUTURE VALUE FOR A ONE-TIME INVESTMENT

We will start with calculation of the future value when a single investment is
made. The mathematical formula to compute the future value is:
FV = PV (1+R) ^n
FV = Future value
PV = Present value
R = Rate of return
N = Number of periods

Go to fx, select category: Financial, select FV and then press ok

1. An investor deposits into a bank Rs. 10,000 which pays 8% interest per annum compounded
annually. How much money will he get after
(a) 10 years
(b) 12 years
2. An investor deposits Rs. 50,000 in a security that is AAA rated. It pays 10% interest compounded
semi-annually. How much money will be available on this after 8 years?

3. A person borrowed Rs. 1,00,000 at 8% per annum, compounded quarterly. What amount does he
have to pay back after 5 years?

4. Saurabh invests Rs. 40,000 in a fixed deposit which pays him 8% interest per annum compounded
monthly. How much will he get after 5 years?

EFFECTIVE ANNUAL INTEREST RATE

The effective annual interest rate is the true interest rate on an investment or loan because it takes into
account the effects of compounding.
The more frequent the compounding periods, the higher the rate.
It is also called the effective interest rate, the effective rate, or the annual equivalent rate (AER).
The formula for converting the nominal rate of interest into an effective annual
interest rate is as follows:
Effective annual rate = {(1 +i) ^m – 1} × 100
i = Nominal rate of return
m = Number of compounding in a year
Rate (i) here will be the monthly rate if compounding is monthly, quarterly
if compounding is the quarterly, semi-annual rate if it is half-yearly, and the annual rate
if the compounding is annual.

1 Monthly compounding
= {(1+1%) ^12 – 1)} × 100
= {(1.01) ^12 – 1)} × 100
= 12.6825%

2 Quarterly compounding
= {(1.03) ^4 – 1} × 100
=12.5508%

3 Semi-annual compounding
= {(1.06) ^2 – 1} × 100
=12.36%

4 Annual compounding
= {(1.12) ^1 – 1} × 100
=12%
Ex: If a person takes a loan of Rs. 2,00,000 at 9% per annum nominal interest,
what would be the interest paid at the end of the year if compounding is
(a) Annual
(b) Semi-annual
(c) Quarterly
(d) Monthly

PRESENT VALUE OF ONE-TIME INVESTMENT

The formula to calculate PV when FV is given will be as follows:

PV = FV/(1+r) ^n

1. What amount should be invested now for it to become Rs. 85,000 in 5 years when the rate of
return is 9% per annum and compounding is done once a year?

2. What amount would Mr. Ashok need to invest to get Rs. 5,00,000 after 6 years? He is a
moderate risk taker and likes his investment to be made in a balanced fund where the return
can be estimated at 12% to be on the conservative side.

3. What should be preferred:

(a) Rs. 1,00,000 today
(b) Rs. 1,40,000 2 years later
(c) Rs. 1,60,000 3 years later
4. when the rate of interest is 8% per annum and compounding is done annually?

5. What amount would need to be invested to grow to Rs. 50,000 in 8 years if compounding is done
semi-annually as is done in RBI taxable bonds, if the rate of interest was 11% p.a.?

6. How much should be invested for 5 years at 12% rate of return to become Rs. 45,000 when
compounding is done quarterly?

7. What should be invested now to grow to Rs. 2,50,000 in 12 years time at 9% p.a. rate of interest
when compounding is done monthly?

COMPUTATION OF IMPLIED RETURN ON INVESTMENT

This means that we know the present value (PV), the future value (FV), and the number of periods (n) and
we have to compute the implied rate or i.
Go to fx, select the category: Financial, select the rate, and feed the values

Anita invests Rs. 2,00,000 in a diversified equity fund of a mutual fund and it becomes Rs. 8,00,000 in 10
years when compounding is done annually. Compute the implied rate of return on this investment.

Richa invests Rs. 55,000 into a bank fixed deposit which pays semi-annual interest. Richa has given the
option of reinvestment. After 5 years the amount becomes Rs. 85,413.31. Calculate the annual rate of
interest given by the bank?

Rs. 1,50,000 becomes Rs. 2,34,500 in 2.5 years when compounding is done quarterly. Compute the
quarterly rate of interest and the nominal rate.

Soma invested Rs. 65,000 in a fund in which compounding is done monthly. The amount becomes Rs.
1,00,000 in 2 years. Compute the monthly rate of interest and the nominal rate.
COMPUTATION OF THE NUMBER OF PERIODS IN AN INVESTMENT

Go to fx, select category: Financial, select Nper and feed the values

Rate —% or 0.00
PV ———————
FV ———————

How many years will it take for Rs. 50,000 to double when the rate of interest is 12% p.a. and
compounding is done annually?

Mr. Sagar wishes to deposit Rs. 2,50,000 in RBI bonds which give a return of 8% p.a. Compounding is
done semi-annually. It becomes Rs. 3,70,061.07. How many semi-annuals and how many years does it
take?

In how many quarters will Rs. 12,000 become Rs. 18,000 when the rate of interest is 6% p.a. and
compounding is done quarterly?

Rupees 1,50,000 is invested in an instrument which gives 12% rate of interest and compounding is done
monthly. How many months will it take for it to become Rs. 2,72,504.50?

Mr. Saha, who has been working with a multinational company for the last 15 years, is 45 years old and
spends Rs. 5,40,000 annually to maintain his living standard. He wants to maintain the same standard of
living even after retirement. Inflation is @ 5% for the whole 15 year period and even though there will be
an increase in the price of goods and services he would not like to compromise on his living standard.
What amount will be required annually when he retires at age 60?

Miss Monica spends Rs. 2,40,000 p.a. and she wishes to increase her living standard by 3% every year as
she is optimistic about the growth in her career. She is 30 years old and inflation is assumed to be 4.5% for
a 30 year period. How much money per annum will she require at age 60?

Mr. Rajan spends Rs. 3,60,000 per annum to meet his annual living costs. He wishes to maintain the same
standard of living after retirement which will be after 15 years. Inflation in the first 5 years is 5% p.a. and
in the next 5 years it will be 4.5% while in the following 5 years it will be 5.5% p.a. Mr. Rajan feels that at
the age of 60 most of his commitments such as children’s education and marriage will be fulfilled and
therefore he requires only 75% of the expenses from age 60 onwards. How much money will Mr. Rajan
require at the age of 60?

Sudha needs Rs. 5,25,000 after 5 years and Rs. 10,00,000 after 12 years to meet two goals of buying a car
and a house. The rest of the money required to buy a house will be financed by her employer. She has a
long term horizon and can therefore invest in equity which will provide her a 15% return on her
investments. What is the lump sum amount she should invest now in order to meet her two goals at the
appropriate time?

Sneha gets a bonus from her employer every year in the month of April. She invests this money in equity
mutual fund schemes. She has already accumulated Rs. 11,00,000 and the average rate of return on these
investments have been 15% p.a. This year she invested Rs. 2,00,000 in the same type of schemes which
pay her 15% rate of return. Next year she will invest Rs. 3,00,000. How much money will she have in her
account after 10 years if she does not invest after that?

Raman invested Rs. 4,10,000 for 8 years @ 7% p.a. where it was compounded annually for the first 5 years
and quarterly for the last three years. What did he get on maturity?
How many years will it take for Rs. 2,00,000 to become Rs. 3,50,000 when the interest rate is 9% and
compounding is done annually?

Mr. Hari wishes to have Rs. 5,75,000 after 10 years for his son’s higher education. The prevailing rate of
interest is 12% p.a. He has Rs. 2,00,000 in his savings bank account. Is it possible to achieve his goal of
accumulating the required amount after 10 years with this amount? If yes, then calculate the amount of
investment required?

Gautam has Rs. 3,00,000 to invest and he wishes to make this money grow to Rs. 6,03,407.15 in 5 years.
He has the following options available to him and he is a moderate risk taker. Which instrument should he
choose to meet his target of accumulating Rs. 6.034 lakh?

If Rs. 5,000 is invested and grows to Rs. 24,000 in 36 monthly compoundings, calculate the monthly rate
of interest and annualized rate of return.

REAL RATE OF RETURN

For example, suppose a household deposits Rs. 100 with a bank for 1 year and they receive interest of Rs.
10. At the end of the year their balance is Rs. 110. In this case, the nominal interest rate is 10% per annum.
The real interest rate, which measures the purchasing power of interest receipts, is calculated by adjusting
the nominal rate charged to take inflation into account.

Suppose the rate of inflation in the economy is 5% p.a. then the real rate of return will be 4.76%.
The formula to calculate the real rate of return is:

R = [{(1 + r)/(1 + e)} – 1] × 100

R = (1.10/1.05) – 1 × 100 = 4.76% p.a.

RETURN ADJUSTED FOR TAX

Return adjusted for tax = Rate (1– tax rate)

For example an investment providing an annual return of 8% and interest

income that is subject to normal tax rate of 30% + 3% education cess (30.90%),
will give a tax adjusted return of:
= 8 (1 –.3090)
= 8 (.6910)
= 5.528%