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6. Time Value of Money

The document discusses the Time Value of Money (TVM), emphasizing its importance in financial management and investment decision-making. It covers concepts such as future value, present value, compounding, and annuities, along with practical applications and calculations. Additionally, it highlights the factors influencing TVM, including risk, inflation, and investment opportunities.

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Vineeta Agrawal
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7 views39 pages

6. Time Value of Money

The document discusses the Time Value of Money (TVM), emphasizing its importance in financial management and investment decision-making. It covers concepts such as future value, present value, compounding, and annuities, along with practical applications and calculations. Additionally, it highlights the factors influencing TVM, including risk, inflation, and investment opportunities.

Uploaded by

Vineeta Agrawal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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79 per cent of the top CEOs rate Finance

skills, as the most required for the CEO of


the future….. KPMG survey
Time Value of Money
Today’s Agenda

 Understanding the concept


 Application of the Time Value of Money in
Business and Finance
 How to calculate the Time value of Money
Time Value of Money

Value of Money is
different in different
time periods.
Think

Assume if you have one thousand rupees today.


If you lend this money to your friend on a
condition that he will repay it tomorrow.
But if he said, he will pay you after one year,
what will you do?
Will you lend him?
If yes, on what conditions?
Reasons for Time Value of Money
(TVM)

Risk and Uncertainty

Inflation

Consumption

Investment opportunities
Money today is more valuable than
money tomorrow.
Definition

Time Value of Money (TVM) is an important


concept in financial management. It can be
used to compare investment alternatives and
to solve problems involving loans, leases,
savings.
Application of the Time Value of
Money

 Capital Budgeting
 Financing Decisions
 Pricing and Valuation
 Risk Management
 Retirement Planning
 Lease and Rental Agreements
Let’s calculate

When r = 10%
Techniques of converting the value
of money
Concept in Future Value

 Compounding of lump-sum on annual


basis
 Multi –period Compounding
 Annuity
Basic Equation
Future Value and Compounding
Future value refers to the amount of money an investment
will grow to over some length of time at some given
interest rate

FV = PV × (1 + r)n

present value of the cash flow (PV)


interest rate (r), and
time period (n)
Calculate

What is the present value of Rs. 100, to be


received at the end of 1 year?
Mr. X invests in a saving bank account Rs 1000 @ 5% interest
compounded annually for 3 years.

YEAR 1 2 3

Beginning Amt. 1000 1050 1102.50

Interest Rate 0.05 0.05 0.05

Amt. of Interest 50 52.50 55.125

Ending Principle 1050 1102.50 1157.625


Compound Value Table

Jacob is considering investing Rs. 15,000 in bonds


at a rate of interest of 8% for 7 years. How much he
would get after 7 years.

F= 15,000
= 25710
 Suppose Anil’s great grandfather had invested
Rs. 100 for 60 years ago at 10% interest rate.
How much it would have grown till today?
Multiperiod Compounding

General Formula:
FVn = PV0(1 + [r/m])mn

n: Number of Years

m: Compounding Periods per Year


r: Annual Interest Rate
FVn,m: FV at the end of Year n
PV0: PV of the Cash Flow today
 What will be the value of 1,00,000 Rupees
after 5 years if the rate of interest is 10%. What
will be the future compounded value, Calculate
when compounding is done ?
 semi annually,
 quarterly and
 monthly as per the given data.
Techniques of Calculations

Mathematical Formula (Manual or Scientific


Calculator)

MS-Excel

Interest Tables
FUTURE VALUE CALCULATION
USING MS- EXCEL
Caselet

Bob invests $20,000 in a bond that pays an interest


rate of 5% for five years. Bob uses the formula for
simple interest to calculate what his total interest
earned will be at the end of the period. Bob
doesn’t realize that the interest on his bond is
compounded semi-annually. Will Bob get a good
surprise or a bad surprise when he receives his
interest payment at the end of the term? What is
the difference between Bob’s expected total
interest payment and his actual total interest
payment?
Compound Value of an Annuity

An annuity is a fixed
payment (or receipt)
each year for a specified
number of years.
Question on Annuity

: if you deposit Rs. 5000 at the end of every year in a bank


for 5 years and the bank is paying 10% interest, the future
value of this annuity will be Rs.

+5000 + 5000 (1.1) + 5000


The question can also be solved with the formula also
 Findthe amount of annuity if payment of Rs.
5000 is made annually for 7 years at interest rate
of 14% compounded annually.
 A person is required to pay four equal annual
payments of Rs.5,000 each in his deposit
account that pays 8% interest per year. Find
out the future value of annuity at the end of 4
years.
DISCOUNTING CONCEPT
Present Value calculation for a
single sum
Assume interst rate @ 10%
 Rs. 100 now will become Rs. ___ after 1 year.
 Rs. 100 now will become Rs. ___ after 2 year.
 Rs. 100 now will become Rs. ___ after 3 year.
 Thus
 Present Value(PV) of Rs. 100 to be received after 1
year is ____
 Present Value(PV) of Rs. 121 to be received after 2
year is ____
 Find Present Value of ` 80,000 to be received
after five years when required rate of return is
10%

 Assume in the same example, the rate of


return is 15%,
 you want to earn Rs. 1500 in three years at 7%
rate of interest. How much should you invest
today to get Rs. 1,500 in three years?
 Your auto dealer gives you two choices, if your
cost of money is 8%, which do you prefer?
 pay $15,500 cash now,

or
 make three payments:

$8,000 now and $4,000 at the end of the


following two years
Find the present value of cash flows at 5% rate of
interest.
Present Value of Annuity
Determine the present value of Rs. 700 each paid at the end
of each of the next six years. Assume an 8 per cent of interest.
Suppose you need a loan of Rs. 50,000 at the
interest rate of 15%, and you want to repay
your loan in six annual installment. What will
be the annual payment?

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