Sinking Fund

• In simple words, it is a method to find the

annuity of Future value we pay.
• Formula
i A = Annuity/SF
FV FV = Future Value
(1+i)n – 1 i = Compounding rate

n = Compding prd
 Uses of Sinking Fund
• To find the annuity required to avoid a
lumpsum expense in future (Future Value)
• Plan for replacement cost of machine
• To find the premium of insurance
• To find the annuity of a recurring deposit
• But not to find EMI of a loan because there is
no future value in loan from the buyers point
of view
 Problems
• Find the annual payment of a investment scheme which is
going to give you Rs 1lakh after 5 years. Interest rate is 10%

-16,379.75

• Find the monthly payment of RD which is going to give you

Rs 5 lakhs after 10 years. Interest rate is 6% compounds
monthly – 3051.03

• Find the premium (Annuity) per quarter of an insurance

scheme which is going to give you Rs 10 lakhs after 25 years.
Interest rate is 12% and it compounds quarterly – 1646.67
 Present Value
• Present Value of Lump sum – Todays
investment on Fixed Deposit
• Present Value of Annuity – Purchase of
annuity
 Present Value of Lump-sum
• The lump sum amount required today to
receive a lump sum in future
• Eg. Today’s amount to deposit in Fixed deposit
 Formula
FV
PV =
(1+i)n
PV = Present Value
FV = Future Value
i = Discount rate
n = Time/No of compounding in total Period
 Problem
• Find the present value of Rs 10000 received after 3
years if the interest rate is 10% - 7513.48
• Find the present value of Rs 145000 received after 3
years if interest rate is 14% and it compounds twice in a
year – 96619.62
• Find the present value of Rs 300000 received after 3
years, if the interest rate is 12% and compounding
happens monthly – 209677.48
 PV of Annuity
• Amount received in periodic interval is
Annuity (Future Value)
• To receive the annuity in future how much
should I invest today? (Present Value)
• The amount invested today is lumpsum
• Eg. Purchase of annuity, loan provided by a
banker, etc.
 Formula
1 1
P=A -
i i(1+i)n

P = Present Vale
A= Annuity you receive (Future Value)
i = Discounting rate
n = No of compounding in the total period
 Problems

• Determine the PV of Rs 1000 received at the end of

every year for 6 years. Assume 8% interest –
4622.88
• Find the PV of Rs 3000 receive once in every 6
months for a period of 10 years. Assume interest
12% and it compounds every semi annual –
34409.76
 Capital Recovery & Loan Amortization
• Annuity of an investment made today for a
specific period of time at a given rate
• To find the annuity of present value
• Used to find the EMI of loans
• But not used to find insurance premium,
annuity of RD, etc because they have only
future value but no present values
 Formula

1 PV = Present Value
A = PV A = Annuity
1 1 n = total discount prd
i i(1+i)n i = discount rate
 Problem
• You invest a lumpsum of Rs 10000 today for a
period of four years. If your interest rate is
10%, how much income per year should you
receive to recover your investment
 Find the EMI
• A home loan of Rs 50 lakhs with repayment
period is 25 years and interest in 12% -
• EMI of a car loan of Rs 8 lakhs with repayment
period of 7 years and interest rate is 15%
 PV of uneven cash flows
• It is a type of PV of Annuity but cash flow of
annuity is not constant
• Every period the cash flow will be uneven or
irregular
• Eg SWP of a mutual fund, dividend paid by
equity share, etc
 PV of uneven cash flow
Formula
A1 A2 An
PV = + + ………………..
(1+i)1 (1+i)2 (1+i)n

A= Cash flow per period

n= time
i = Discount rate
 Problem
An investor has an opportunity to receive Rs
1000, Rs 1500, Rs 800, Rs 1100 and Rs 400
respectively at the end of one through four years.
Find the present value of this stream of cash
flows when the interest rate or the discount rate
is 8%
Answer = 3927.60
 PV of Growing Annuity
• The Annuity will grow at a constant growth rate
every period

1 (1+g)1 (1+g)2 (1+g)n-1

PV =A + + + …….+
(1+i)1 (1+i)2 (1+i)3 (1+i)n

A= Annuity, g=Growth Rate, i = Discount Rate, n = period

 Problem
Your employer fixes an annual salary of Rs 1500
with the provision that you will get annaual
increment of 12%. Assume 15% discount rate
and find the present value of your salary for 5
years?
PV = 4307.67
 Capital Budgeting Decisions
• Method to evaluate and choose the best investment from
the available alternatives
• A firms decision to invest the current funds most
efficiently in long term assets with the aim of earning
benefits in future
• Decision on exchange of funds for future benefit

• Decision on funds invested for long term

• Benefits are expected over a series of years

 CBD Techniques
• Discounted Cash Flow (DCF) – Uses Time
value of Money
• Non Discounted Cash Flow
 CBD Techniques
• Discounted Cash Flow
– Net Present Value (NPV)
– Internal Rate of Return (IRR)
– Profitability Index (PI)
• Non-Discounted Cash Flow
– Payback Period (PB)
– Accounting Rate of Return(ARR)
 Net Present Value (NPV)
• Its at DCF method which uses time value of
money to assess an investment
• Discounts all the future cash flows to present
and compare the same with investment
• Simply find the present value of all future cash
flows from the investment
 Steps in NAV Calculation
• Cash flows of investment is forecasted based
on realistic assumptions
• Appropriate discounted rate is identified
• Find the present value of cash flows using the
discount rate
• NPV is found by subtracting PV of cash
outflow from PV of cash inflows
 Discount Rate
• It’s the i value for PV calculation
• It’s the projects opportunity cost of capital
• Its also required rate of return expected by the
investor
 Decision Rule
• NPV > 0; Accept the project
• NPV < 0; Reject the project
• NPV = 0 May accept or reject the project
 NPV formula

NPV = PV of Cash inflow – PV of Cash outflow

For Lumpsum cash inflow
NPV = PV of lumpsum – PV of cash outflow
For Annuity Cash flow
NPV = PV of Annuity – PV of cash outflow
For Uneven Cash flow
NPV = PV of Uneven Cash flow – PV of cash
outflow
 Discount
Sl No Investment Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 rate NPV
1 10000 10000 0 0 0 0 0 10% -909.09
2 10000 7500 7500 0 0 0 0 10% 3016.53
3 10000 2000 4000 12000 0 0 0 10% 4139.74
4 10000 10000 3000 3000 0 0 0 10% 3824.19
5 10000 10000 0 0 0 0 0 30% -2307.69
6 10000 7500 7500 0 0 0 30% 207.10
7 10000 2000 4000 12000 0 0 0 30% -632.68
8 10000 10000 3000 3000 0 0 0 30% 832.95
9 250000 75000 75000 75000 75000 75000 75000 12% 58355.55
10 375000 100000 75000 68000 125000 145000 85000 13% 15551.09
11 100000 30000 30000 30000 30000 30000 30000 15% 13534.48
12 -81000 40000 35000 30000 0 0 0 15% 161973.12
13 1000 600 200 200 1000 0 0 10% 544.02
14 1000 200 200 600 1000 0 0 10% 480.91
15 300 100 100 100 600 0 0 10% 358.49