TIME VALUE

OF MONEY
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CONCEPT
 A rupee, which is received today is more valuable than a
rupee receivable in future. The amount that is received in
earlier period can be reinvested and it can earn an additional
amount.

 Individuals prefer value opportunity to receive money now

rather than waiting for one or more years to receive the same.

 There are three reasons, that may be attributed to the

individual’s time preference for money:
 Uncertainty
 Current Consumption
 Possibility of investment Opportunity
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SIMPLE INTEREST
 Simple interest is the interest paid (earned) on the original
amount, or principal borrowed (lent).

 Simple interest is the function of three components such as

principal amount borrowed or lent, interest per annum and
number of years for which the interest rate is calculated.

 Simple interest is calculated as follows:

 SI=P x n x r
 P= Principal amount
 n= No. of years
 r= Rate of interest
 Future value: 3

 FVn=P+SI
COMPOUND INTEREST
 There is a significant difference between simple and
compound interest.

 In simple interest there is no opportunity to earn interest on

interest whereas in compounding interest each interest
payment is reinvested having an opportunity to earn interest
on interest.

 Compound interest is the interest earned on a given deposit

and has become a part of principal at the end of the specific
period.

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 Compounding interest is also referred to as future value.
 It can be calculated as follows:
 Annual compounding:

 FVn= P0(1+r)ⁿ
 FVn= Compound Value at the end of “n” year
 P0=Principal amount
 n= No. of years
 r= Rate of interest

 Variable compounding periods

 FVn= P0[1+r/m]m*n
 FVn= Compound Value at the end of “n” year
 P0=Principal amount
 n= No. of years
 r= Rate of interest 5

 m= no. of times compounded in a year.

 Q.1. Suppose you have ₹10,00,000 today and you deposit it with a financial
institute, which pays 8% interest for a period of 5 years. Show how the
deposit would grow:

 If Financial institute gives Simple Interest per annum

 If Financial institute gives Compound Interest per annum

 If Financial institute gives Compound Interest Semi-annually

 If Financial institute gives Compound Interest Quarterly

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 Compounded value of a series of cash flows:
 Uneven Cash flows:

 When investment is done at the end of the year

 FVn=P1(1+r)n-1 +P2(1+r)n-2 +…..+Pn-1(1+r)+Pn

 When investment is done in the beginning of the year

 FVn=P1(1+r)n +P2(1+r)n-1 +…..+Pn-1(1+r)2+Pn (1+r)

 FVn= Compound Value at the end of “n” year

 P1=Payment at the end of year one
 P2=Payment at the end of year two
 Pn=Payment at the end of year n
 n= No. of years
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 r= Rate of interest
 Q.2. Mr. Shyam deposits ₹ 5,000; ₹ 10,000; ₹ 15,000; ₹
20,000; and ₹ 25,000 in his savings bank account at the end
of year 1,2,3,4 and 5 respectively. Interest rate is 6% per
annum. He wants to know his future value of deposit.

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 Q.3. Suppose you deposit in the beginning of each year ₹
750, ₹ 1,000, ₹ 1,250, ₹ 1,500 and ₹ 1,750 in your savings
bank account 1 to 5 years respectively. What are your
deposits compound value at the end of 5 years? Interest rate
is 6% per annum.

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ANNUITY
 Even Cash flows:
 Annuity is a series of even cash flows of a fixed amount
for a specified number of years.

 Cash flows may happen either at the end of the year or

beginning of the year.

 If cash flows happen at the beginning of the year, it is

called as an annuity due, whereas when cash flows
happen at the end, it is called as a regular or deferred
annuity.
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 Compound value of Deferred Annuity:

The formula is arrived at Using Sum of GP:

 FVan= P (1+r)n – 1
r
 Compound value of Annuity Due:

 FVan= P (1+r)n – 1 (1+r)

r

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 Q.4. Mr. Ram deposits ₹500 at the end of each year for 6
years at 6% interest. Determine Ram’s money value at the
end of 6 years.

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 Q.5. Suppose you deposit ₹ 2,500 at the beginning of each
year for 6 years in a savings bank account at 8% compound
interest. What is your money value at the end of 6 years?

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CONTINUOUS COMPOUNDING
 Value of compounding depends upon its frequency.

 The value rises exponentially in case of continuous

compounding.

rt
FVn = P x e
e  2.7183
PRESENT VALUE
 Present value is exactly contrary to compound value.

 Compound value is helpful to know the interest added to

principal amount at a given compound interest rate and given
number of years, whereas in the present value is sum that is
receivable in the future.

 In simple words, under compounded approach the sum

invested will appreciate whereas in present value the sum
receivable in future will depreciate due to discounting.

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 The processes of determining present value of a future cash
flows (inflows and outflows) is called discounting.

 The present value of a future cash flow (inflow/outflow) is the

amount of current cash that is of equivalent value to the present
value.
 It can be calculated as follows:

PV= CIF 1
(1+r)n

 PV= Present Value

 CIF= Cash inflow receivable at the end of “n” year
 n= No. of years
 r= Rate of interest or Discounting rate
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 Q.6. An investor wants to find out the present value of ₹
40,000 due in 3 years if interest rate is 10% per annum.

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SHORTER DISCOUNTING
PERIODS
 Generally, cash flows are discounted once in a year, but
sometimes cash flows have to be discounted less than one
year time, like, semi-annually, quarterly, monthly or daily.

PV= CIF ____1___

(1+r/m)nm

 PV= Present Value

 CIF = Cash inflow receivable at the end of “n” year
 n= No. of years
 r= Rate of interest or Discounting rate
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 Q.7. Mr. “A” expected to receive ₹1,00,000 at the end of 4
years. His required rate of return is 12% per annum. He
wants to know PV of 1,00,000 if it is quarterly discounting.

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 Present value of a series of cash flows:
 Uneven Cash flows:

 When discounting is done at the end of the year

 PV=CIF 1 + CIF 2 +…..+ CIF n

(1+r)1 (1+r)2 (1+r)n

 When discounting is done in the beginning of the year

 PV= CIF 1 + CIF 2 +…..+ CIF n

(1+r)0 (1+r)1 (1+r)n-1

 PV= Present Value

 CIF= Cash Inflows
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 n= No. of years
 r= Rate of interest or Discounting rate
o Q.8. From the following information, calculate the present value of
cash inflow at 10% interest rate if amount is received in the beginning
of the year.

Year 0 1 2 3 4 5

Cash inflow (in ₹) 2,000 3,000 4,000 5,000 4,500 5,500

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 Q.9. Find the present value of an income stream which
provide ₹500, ₹1,000, ₹1,500, ₹2,000 and ₹2,500 at the
end of 1 to 5 years respectively if interest rate is 12% per
annum.

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PRESENT VALUE OF ANNUITY
 Present value of annuity deferred
 PVan= CIF (1+r)n – 1

r (1+r)n

 Present value of annuity due

 PVan= CIF (1+r)n – 1 (1+r)

r (1+r)n

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 Q.10. Mr. Ram wishes to determine the PV of the annuity
consisting of cash flows of ₹ 40,000 per annum for 6 years.
The rate interest he can earn from his investment is 10%.

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 Q.11. Mr. Krishna has to receive ₹ 500 at the beginning of
each year for 4 years. Calculate present value of annuity due
assuming 10% rate of interest.

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PRESENT VALUE OF GROWING
ANNUITY
 Growing annuity means the cash flows that grows at a
constant rate for a specified period of time.
 Present value of growing annuity deferred:

 1-

 Present value of growing annuity due:

 1- (1+r)

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 Q.12. XYZ Real Estate Agency has rented out one of their
apartments for 5 years at an annual rent of ₹ 6,00,000 with
the stipulation that rent will increase by 5% every year. If the
agency’s required rate of return is 14%, what is the PV of
expected (annuity) rent.

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Year CIF CIF PVIF (r =14%) PV

1600000(1+g)^0 600000 1 600000

2600000(1+g)^1 630000 0.877 552632

3600000(1+g)^2 661500 0.769 509003

4600000(1+g)^3 694575 0.675 468818

5600000(1+g)^4 729303.8 0.592 431806

25,62,259

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CONTINUOUS DISCOUNTING
 Value of discounting depends upon its frequency.

 Thevalue falls exponentially in case of

continuous discounting.

1
PV= FV x rt = FV x e -rt
e
e  2.7183
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PRESENT VALUE OF
PERPETUITY
 Perpetuity is an annuity of infinite duration.

PV  = CIF
r

PV  = Present value of perpetuity

CIF = Constant cash inflow
r = Rate of interest or Discounting rate

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Q.13. Mr. “A” an investor expects a perpetual amount of ₹
1,000 annually from his investment. What is the present
value of perpetuity if the interest rate being 8%?

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PRESENT VALUE OF GROWING
PERPETUITY
 It assumes that the cash flows (dividends) associated with the certain
investments (stocks) are known in the first period and will grow at a constant
compound rate in subsequent periods.

 More generally, this is growing perpetuity:


PVg = CIF_
r-g

 The growing perpetuity expression simply subtracts the growth rate from the
discount rate; the growth in cash flows helps to “cover” the time value of
money.

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 This formula for evaluating growing perpetuities can be used only when r > g.
Q.14. If a stock is paying dividend of 100 in year one and is
expected to increase its dividend payment by 10% each year
thereafter. What is the present value of perpetuity if
discounting rate13%?

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LOAN INSTALLMENT AND
AMORTIZATION
 Loan is an amount raised from outsiders on an interest and
repayable at a specific period (lump sum or in installments)
 Payment of loan is known as amortization.

LI= Loan installment

PA= Principle amount borrowed
r = Rate of interest or Discounting rate

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Q.15. ABC company raised ₹ 10,00,000 for an expansion
program from IDBI bank at 7% per annum. The amount to be
repaid in 6 equal annual installments. Calculate loan
installment amount and also prepare loan amortization
schedule.

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EMI
 EMI (Equated monthly installment) refers to as the monthly
payment towards interest and principal amount by the
borrower to the lender.

 EMI is calculated using a formula that considers loan

amount, interest rate and loan period as variable.

 EMI = PA r/12 (1+r/12)n12

(1+r/12)n*12 – 1

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Q.16. Assuming a loan amount of ₹ 1,00, 000, at 9% to be
repaid in 5 years, calculate EMI (Equated monthly
installments)

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SINKING FUND FACTOR
 Financial manager may need to estimate the amount of
annual payments so as to accumulate a predetermined
amount after future date to purchase assets or to pay a
liability.

 P = FVan r
_______ _______

(1+r)n – 1

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Q.17. ABC ltd. has 10,00,000 bonds outstanding. Bank
deposits earn 10% p. a. The bonds will be redeemed after
15years for which ABC ltd wishes to create a sinking fund.
How much amount should be deposited to the sinking fund
each year so that ABC should have amount to retire its entire
issue of bonds.

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Q.19. An executive is about to retire at the age of 60. His
employer has offered him two post retirement plans.
(a)20,00,000 lump sum, (b)2,50,000 each year for 10 years.
Assume 10% interest rate, suggest which is a better option?

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Q.20. As winner of a competition, you can choose one of the
following prizes if the interest rate is 12%, which is the most
valuable prize?
a. ₹100,000 now
b. ₹180,000 at the end of fifth year
c. ₹11,400 per year forever.
d. ₹19,000 each year for 10 years
e. ₹ 5000 in year one and rising thereafter by 5% per year forever.

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EFFECTIVE VS. NOMINAL RATE
 Nominal rate is the rate of interest per year

 Effective and Nominal rate are equal only when the

compounding is done yearly once, but there will be a
difference, that effective rate is greater than the nominal
rate for shorter compounding periods.

 ERI = (1+r/m)mn -1

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Q.18. Assume the rate of interest is 12%. Compute the annual
percentage/effective rate if interest is paid (a)annually (b)semi-
annually (c)quarterly (d)monthly

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DOUBLING PERIOD AND EFFECTIVE
RATE OF INTEREST IN DOUBLING
PERIOD
 Rule of 72:
 Dp = 72 ÷ r

 ERI = 72 ÷ Dp

 Rule of 69:
 Dp = 0.35 + 69 ÷ r

 ERI = 0.35 + 69 ÷ Dp
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COMPOUND GROWTH RATE
 Compound growth rate can be calculated as follows:

 g: V0(1+r)n =Vn
 g: = Growth rate in percentage

 V = Variable for which the growth rate is needed to be found

 V0 = Variable value at the end of the year 0

 Vn = Variable value at the end of year n

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Q.21. From the following dividend data of a company calculate
compound rate of growth for period 2014-2019.

Year 2014 2015 2016 2017 2018 2019

DPS 21 22 25 26 28 31

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Q.22. An investor is 50 years of age today. He will retire at the
age of 60. In order to receive Rs.2,00,000 annually for 10 years
after retirement, how much amount should he have at the time
of retirement? Assume the required rate of return is 10%.

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Q.23. Exactly 10 years from now Shri Chand will start receiving
a pension of Rs.3,000 a year. The payment will continue for
sixteen years. How much is the pension worth now, if Shri
Chand’s interest rate is 10%?

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Q.24. Sagar wishes to accumulate Rs.80,00,000 by the end of 5
years by making equal annual year-end deposits over next 5
years for his son’s higher studies. Assuming 7% rate of return,
how much he should deposit at the end of each year to
accumulate this amount?

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 Q.25. Mohan bought a share 15 years ago for Rs. 10. It is
now selling for 27.60. What is the compound growth rate in
the price of the share?

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Q.26. As a winner of a competition, you can choose one of the
following prizes:
 Rs. 800,000 now

 Rs. 20,00,000 at the end of 8th year

 Rs. 1,00,000 a year forever

 Rs. 1,30,000 per year for 12 years

If the interest rate is 12 percent, which prize has the highest

present value?

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 Q.27. Harris has just bought a scratch lottery ticket and
won Rs 100,000. He wants to finance the future study of
his newly born daughter and invests this money in a fund
with a maturity of 18 years offering a promising yearly
return of 6%. What is the amount available on the 18th
birthday of his daughter?

 Q.28. Patole considers buying a house. Currently, he

pays a rent for Rs 50,000 a month. The current monthly
interest rate on home loan is 0.5%. His planning period
is 20 years. If he doesn’t want to increase his housing
costs, what amount of loan is available for his purchase?

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Q.29. IDFC bank is advertising that if you deposit Rs 2,00,000
with them, and leave it there for 60 months, you can get Rs
4,00,000 back at the end of this period. Assuming monthly
compounding, what is the monthly rate of interest paid by the
bank?

Q.30. Amol wishes to retire 20 years from now and expects to

live for 15 years thereafter. He wishes to have a yearly pension of
Rs. 2,00,000 for 15 years he will live after retirement. He wants
the pension to start one year after retirement. If the interest rate is
8% and expected to remain same, what lump sum amount should
Amol set aside today to facilitate this?

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EXCEL FUNCTIONS
Parameter Symbol Built in formula in excel

Present value PV =PV(rate, nper, pmt, [fv], [type])

FV (if omitted—it’s assumed to be 0 and PMT must be
included)
Type : When payments are made (0, or if omitted—assumed
to be at the end of the period, or 1—assumed to be at the
beginning of the period)

Future Value FV =FV(rate,nper,pmt,pv,type)

No of continuous successive Periods NPER =NPer(rate, pmt, pv, fv, type)

Payment per period PMT =PMT(rate,nper,pv,[fv],[type])

Interest rate RATE =Rate(nper,pmt,pv,fv,type,guess)

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