TIME VALUE OF MONEY

1
 Time Value of Money
• Time value of money means that “worth of a
rupee received today is different from the
worth of rupee to be received in future”. The
preference for money now, as compared to
future money is known as time preference of
money.
• The concept of time value of money tells us
that the value or real worth of any sum of
money is dependent on, ‘the point of time
when it is received or paid’? 
 Time Value of Money –
Importance
Inflation- Because of inflationary
conditions, the rupee today has a higher
purchasing power than rupee in future.
Uncertainty-Since the future is
characterised by uncertainty,
individuals/business concerns prefer to
have current income rather than having
the same payment at a later date.
 Time Value of Money –
Importance
• As such a financial manager of any business
concern cannot ignore the concept of time
value of money while making any financial
decisions, otherwise his decisions will be
invalid and incorrect also.
Simple Interest and Compound Interest
Compound
Simple Interest
Interest

FV = PV {1+r x n} FV = PV {1+r } ^ n

What is the future value of What is the future value of

Rs.1000 after 5 years @12 Rs.1000 after 5 years @12
per cent interest? per cent interest?

FV = 1000 {1 + (0.12 * 5)} FV = 1000 {1 + 0.12 } ^ 5

=1000 (1.12)^5

= 1600 = 1762.34
 SIMPLE INTEREST

• SIMPLE INT FOR 1ST YR =

• COMPOUND INTEREST FOR YOUR 1ST YR
• COMPOUND INTEREST

• PV= 100
• 5 YRS
• 5%
• 1ST YR INT = 5
• 2ND YR INT = 105 X 5% (100+5)
• = 5.25
• 3rd yr int = (105+5.25) X 5% = 5.512
• 4TH YR INT = (100+5+5.25+5.512) X 5%= 5.788
• 5TH YR INT = 121.55 X 5% = 6.0775
 Techniques
• There are two techniques for converting the
sums of money to a common point in time:
 Compounding Technique -
 Discounting Technique
Compounding and discounting are the two sides of the same coin. If
present values are carried into the future, it is called ‘compounding’
and if future values are transferred into present, it is called
‘discounting’. 
 Compounding Technique
•• Future
  value relies on compound interest to measure the value of future
amounts.
• When interest is compounded, the initial principal/deposit in one period, along
with the interest earned on it, becomes the beginning principal of the
following period and so on.
• The compounding of interest can be calculated by the following equation:

in which: A = amount at the end of the period

P = principle at the beginning of the period
i = rate of interest
n = number of years
 FUTURE VALUE OF A SINGLE
CASH FLOW
Suppose you invest Rs.1,000 for three years in a
Fixed deposit account that pays 10% interest
p.a. If you let your interest income be
reinvested, your investment will grow as follows:

AMOUNT= P (1+R)^N
= 1000(1+0.10)^3
= 1331
10
 FUTURE VALUE OF A SINGLE
AMOUNT
First year :
Principal = Rs. 1,000
Interest for the year Rs. 100
Principal at the end Rs. 1,100
Second year :
Principal = Rs. 1,100
Interest for the year Rs. 110
Principal at the end Rs. 1,210
Third year :
Principal = Rs. 1,210 Interest for
the year Rs. 121
Principal at the end Rs. 1,331

11
 FUTURE VALUE OF A SINGLE
AMOUNT
• Alternatively, future value interest factor
(FVIF) table can be used.
Suppose you deposit Rs. 1,000 today in a bank
@10%p.a. interest compounded annually. How
much will the deposit grow to after 8 years and
12 years?
T = FACTOR X PAYMENTS AMOUNT = 1000 (1+0.10)^ 8
T(FVIF 10%,8) = 2143.59
=2.144 X 1000 AMOUNT = 1000 (1+0.10)^
= 2144 12
T = 3.138 X 1000 = 3138.43 12

= 3138
 FUTURE VALUE OF A SINGLE
AMOUNT
Future value interest factor FVIF(r,n)

http://highered.mheducation.com/sites/0072994029/student_view0/present_and_future_value_tables.ht 13

ml
 FUTURE VALUE OF A SINGLE
AMOUNT
• The future value 8 years hence will be:
Rs. 1,000(1.10)8 = Rs.1,000(2.144)

= Rs. 2,144
• The future value 12 years hence will be:
Rs. 1,000(1.10)12 = Rs.1,000(3.138)

= Rs. 3,138
14
 Future Value of Single Cash Flow

• Illustration: What is the future value of Rs100 if interest is

compounded annually at a rate of 6% for three years?

FV= 100 * (1+0.06)^3= Rs119.10

• Illustration: Rs. 1,000 invested at 10% is compounded annually

for three years, Calculate the Compounded value after three years.

• A = P (1+i)^n
• A = 1000 (1 + .10)^3
• A = 1,331
 Future Value: Lumpsum

What will be the value 10 years hence of a

deposit of Rs.20,000 made today if the interest
rate is

4 percent 9 percent
FVIF = FVIF =
(1+0.04)^10 (1+0.09)^10
FV=PMT(FVIF 4%,10) FV=PMT(FVIF 9%,10)
20,000 x FVIF (4%, 10 years) = 20,000 x FVIF (9%, 10 years) =
20,000 x1.480 = Rs.29,600 20,000 X 2.367 = Rs. 47,340
 Future Value of Series of Cash Flows
UNEVEN CASH FLOWS

• Mr. Manoj invests Rs. 500, Rs. 1,000, Rs. 1,500, Rs. 2,000 and Rs. 2,500 at the end of
each year. Calculate the compound value at the end of 5 years, compounded annually,
when the interest charged is 5% p.a.

Answer: Amount at the end of the 5th Year Rs. 8020.50

FV = (500X(1.05)^4)+(1000X(1.05)^3)+(1500X(1.05)^2)

+(2000X(1.05)^1)+(2500X(1.05)^0)

=8019.13
• Interest can be compounded :
 annually,
 semiannually (half-yearly),
 quarterly,
 monthly and
 so on.

• The more frequently interest is compounded, the

larger the future amount that would be accumulated
and the higher the effective interest rate.
 SHORTER COMPOUNDING PERIOD
Future value = Present value 1+ r m x n (RAISED TO)
m
AMOUNT= P X
Where r = nominal annual interest rate
m = number of times compounding is done in a
year
n = number of years over which compounding is
done
Example : Rs.5000, 12 percent, 4 times a year
(QUATERLY), 6 years
TOTAL PERIOD= MXN
5000(1+ 0.12/4)4x6 = 5000 (1.03)24
Future Value: Intra Year Compounding

Suppose you deposit Rs.5000 in a bank for 6 years. If

the interest rate is 12 percent and the frequency of
compounding is 4 times a year. Your deposit after 6
years will be …

FVn = PV x [1+r / m] )^ m*n

FV =5,000 x [ 1 + 0.12/4] ^ 4*6

= 5000 x (1.03)^24
= 5000 x 2.0328
= Rs. 10,164
 EFFECTIVE VERSUS NOMINAL RATE
r = (1+k/m)m –1
r = effective rate of interest
k = nominal rate of interest
m = frequency of compounding per year
Example : k = 8 percent, m=4
r = (1+.08/4)4 – 1 = 0.0824
= 8.24 percent
Nominal and Effective Rates of Interest
Effective Rate %
  Nominal Annual Semi-annual Quarterly Monthly
Rate % Compounding Compounding Compounding Compounding
8 8.00 8.16 8.24 8.30
12 12.00 12.36 12.55 12.68
 Effective Annual Rate

Frequency m Formula EAR

Annual 1 0.12 112.000

Semi-annual 2 [1 + (0.12/2))^2 - 1 112.360

Quarterly 4 [1 + (0.12/4))^4 - 1 112.550

Monthly 12 [1 + (0.12/12))^12 - 1 112.680

Weekly 52 [1 + (0.12/52))^52 - 1 112.730

Daily 365 [1 + (0.12/365))^365 - 1 112.750

tending to
Continuous infinity
e ^0.12 - 1 112.750
 Continuous Compounding

Tina invested $3000 in a bank that pays an annual

interest rate of 7% compounded continuously.
What is the amount she can get after 5 years from
the bank? Round your answer to the nearest
integer.
 Continuous Compounding

Tina invested $3000 in a bank that pays an annual

interest rate of 7% compounded continuously. What is
the amount she can get after 5 years from the bank?
Round your answer to the nearest integer.
Solution
To find: The amount after 5 years.
The initial amount is P = $3000.
The interest rate is, r = 7% = 7/100 = 0.07.
Time is, t = 5 years.
 DOUBLING PERIOD
Thumb Rule : Rule of 72 (APPROXIMATE)
72
Doubling period = Interest rate
Interest rate : 15 percent ANY AMOUNT
72 INVESTED 15%
Doubling period = 15 = 4.8 years

A more accurate thumb rule : Rule of 69 (ACCURATE)

69
Doubling period = 0.35 + Interest rate
Interest rate : 15 percent
69
Doubling period = 0.35 + 15 = 4.95 years
DOUBLING PERIOD

They are useful for investors who require some

quick references to see the number of years for their
investment to double WITHOUT referring to any
present value and future value tables or using a
financial calculator.
Till here for CEC-1
 ANNUTITY

• ORDINARY/ DEFERRED – CASH FLOWS FOR

END OF THE YEAR
• ANNUITY DUE – CASH FLOWS AT THE
BEGINNING OF THE YEAR
 Future Value of Annuity

• Illustration: Mr. K. K. Prasad deposits Rs. 100 at the end of each year for five
years at the interest rate of 5 % compounded annually in a bank.

• FV= PV x (1+r)^n
• =(100 (1.05)^0)+(100 (1.05)^1) +(100 (1.05)^2)
• + (100 (1.05)^3) +(100 (1.05)^4)

= 552.56
FV= PV x  (1+r)^n
PV =
 Future Value of Annuity

• The calculation of future value of annuity is as follows:

• FVn = Rs. 100 (1.05)^4 + Rs. 100 (1.05)^3 + Rs. 100

(1.05)^2 + Rs. 100 (1.05)^1 + Rs. 100

• FVn = Rs. 100 (1.216) + Rs. 100 (1.158) + Rs. 100 (1.103) +
Rs. 100 (1.050) + Rs. 100

• FVn = Rs. 121.55 + Rs. 115.76 + Rs. 110.25 + Rs. 105.50 +

Rs. 100

• FVn = Rs. 553.05

 Future Value of Annuity

• PMT = PVA
• For the end of the year=
FV = PVA x [(1+r)^n – 1}/ r
=100((1.05)^5-1)/0.05
• For the beginning of the year=
FV = PVA x (((1+r)^n – 1)/ r ) x(1+r)
 Future Value: Ordinary Annuity
Suppose Rs.1000 is deposited in the bank annually for a
period of 5 years and the deposits earn a compound
interest of 10 per cent. What is the value of the series at
the end of 5 years?
FV = PMT X FVIFA
FVIFA = [(1+r)^n – 1}/ r

FV = PVA x [(1+r)^n – 1}/ r

FVIFA = [(1+0.10)^5 – 1] /
0.10

FV =1,000 x FVIFA (10%, 5 years)

= 1,000 x 6.105 = Rs.6105
 Future Value: Annuity Due
Suppose Rs.1000 is deposited in the bank annually for a
period of 5 years at the beginning of each year and the
deposits earn a compound interest of 10 per cent. What
is the value of the investment at the end of investment
period?
FVIFA = {[(1+0.10)^5 – 1] /
0.10} * (1+r)
FV= PVA x [(1+r)^n – 1}/ r] * (1+r)

FV =1,000 x FVIFA (10%, 5 years) x

1.1
= 1,000 x 6.105 x 1.1 = Rs.6715.5
 WHAT LIES IN STORE FOR YOU
Suppose you have decided to deposit Rs.30,000 per year in your
Public Provident Fund Account for 30 years. What will be the
accumulated amount in your Public Provident Fund Account at
the end of 30 years if the interest rate is 11 percent ?

FV = PVA x [(1+r)^n – 1}/ r

=30000((1.11)^30-1)/0.11
=5970626.34
 WHAT LIES IN STORE FOR YOU
Suppose you have decided to deposit Rs.30,000 per year in your
Public Provident Fund Account for 30 years. What will be the
accumulated amount in your Public Provident Fund Account at
the end of 30 years if the interest rate is 11 percent ?
The accumulated sum will be :
Rs.30,000 (FVIFA11%,30yrs)
  = Rs.30,000 (1.11)30 - 1
.11
  = Rs.30,000 [ 199.02]
= Rs.5,970,600
 HOW MUCH SHOULD YOU SAVE ANNUALLY
You want to buy a house after 5 years when it is expected to cost
Rs.2 million. How much should you save annually if your savings
earn a compound return of 12 percent ?

FV = PVA x [(1+r)^n – 1}/ r

2=PVA((1.12)^5-1)/0.12
PVA= 2/ (((1.12)^5-1)/0.12)
=0.314819 X 10,00,000
=314819

PV = FV / FVIFA
= 2000000/ 6.3528
=
 HOW MUCH SHOULD YOU SAVE ANNUALLY
You want to buy a house after 5 years when it is expected to cost
Rs.2 million. How much should you save annually if your savings
earn a compound return of 12 percent ?

The future value interest factor for a 5 year annuity, given an

interest rate of 12 percent, is :
(1+0.12)5 - 1
FVIFA n=5, r =12% = = 6.353
0.12
  The annual savings should be :
Rs.2000,000 = Rs.314,812
6.353
 FINDING THE INTEREST RATE
A finance company advertises that it will pay a lump sum of Rs.8,000 at the
end of 6 years to investors who deposit annually Rs.1,000 for 6 years. What
interest rate is implicit in this offer?

FV = PVA x [(1+r)^n – 1}/ r

8000 = 1000 [(1+r)^6 – 1}/ r
r= 0.1143
R= 11.43%
 future value interest factor of an annuity
FV = PV X FVIFA
8000= 1000 X FVIFA
FVIFA(6,r)= 8.00
FVIFA(12%,6)= 8.11
 FINDING THE INTEREST RATE
A finance company advertises that it will pay a lump sum of Rs.8,000 at the
end of 6 years to investors who deposit annually Rs.1,000 for 6 years. What
interest rate is implicit in this offer?
The interest rate may be calculated in two steps :
1.  Find the FVIFAr,6 for this contract as follows :
Rs.8,000 = Rs.1,000 x FVIFAr,6
FVIFAr,6 = Rs.8,000 = 8.000
Rs.1,000
2.  Look at the FVIFAr,n table and read the row corresponding to 6 years
until you find a value close to 8.000. Doing so, we find that
FVIFA12%,6 is 8.115 . So, we conclude that the interest rate is slightly below
12 percent.
 HOW LONG SHOULD YOU WAIT
You want to take up a trip to the moon which costs Rs.1,000,000 the cost is
expected to remain unchanged in nominal terms. You can save annually Rs.50,000
to fulfill your desire. How long will you have to wait if your savings earn an
interest of 12 percent ?
 HOW LONG SHOULD YOU WAIT
You want to take up a trip to the moon which costs Rs.1,000,000 the cost is
expected to remain unchanged in nominal terms. You can save annually Rs.50,000
to fulfill your desire. How long will you have to wait if your savings earn an
interest of 12 percent ?
50,000 x FVIFAn=?,12% = 1,000,000
50,000 x 1.12n – 1 = 1,000,000
0.12
  1.12n - 1 = 1,000,000 x 0.12 = 2.4
50,000
  1.12n = 2.4 + 1 = 3.4
n log 1.12 = log 3.4
  n x 0.0492 = 0.5315
  n = 0.5315 = 10.8 years
0.0492
You will have to wait for about 11 years.
 ANNUAL DEPOSIT IN A SINKING FUND
Futura Limited has an obligation to redeem Rs.500 million
bonds 6 years hence. How much should the company deposit
annually in a sinking fund account wherein it earns 14 percent
interest to cumulate Rs.500 million in 6 years time ?

 Centre for Financial Management , Bangalore

 ANNUAL DEPOSIT IN A SINKING FUND
Futura Limited has an obligation to redeem Rs.500 million
bonds 6 years hence. How much should the company deposit
annually in a sinking fund account wherein it earns 14 percent
interest to cumulate Rs.500 million in 6 years time ?
The future value interest factor for a 5 year annuity, given
an interest rate of 14 percent is :
FVIFAn=6, r=14% = (1+0.14)6 – 1 = 8.536
0.14  
The annual sinking fund deposit should be :
Rs.500 million = Rs.58.575 million
8.536
 Centre for Financial Management , Bangalore
 Quiz
1. Mr Ramesh deposits Rs. 2,000 at the end of every year for 5 years in his
saving account, paying 5% interest compounded annually. Determine the
sum of money, he will have at the end of the 5th year.

2. Mr. Bhat deposits each year Rs. 5000, Rs. 10000, Rs. 15000, Rs. 20000
and Rs. 25000 in his savings bank account for 5 years at the interest rate of
6 per cent. He wants to know his future value of deposits at the end of 5
years.

3. Suppose you deposit Rs 5000 in a bank for 6 years. If the interest rate is
12% and the frequency of compounding is quarterly, calculate value of
your deposit after 6 years.
 Present Value: Lumpsum

How much you should deposit or invest today if

the interest rate is 5 percent and you will need
Rs.25,00,0 00 to buy your business in five years.
 Present Value: Lumpsum

How much you should deposit or invest today if

the interest rate is 5 percent and you will need
Rs.25,00,0 00 to buy your business in five years.

PV = FV x [1/(1 +i)n] PVIF = 1 /

(1+0.05)^5

PV = Rs. 25,00,000 x PVIF (5%, 5 years)

= 25,00,000 x 0.784
= Rs. 19,58800
 Present Value of Series of Cash Flow

• Given the time value of money as 10% (i.e. the discounting factor), you are
Year
required to find out the present valueCash Flows
of future cash inflows that will be
1 received over the next four years. 1,000
2 2,000
3 3,000
4 4,000
 Present Value of Series of Cash Flow

• Given the time value of money as 10% (i.e. the discounting factor), you are
Year Cash
required to find out Flows valuePresent
the present of futureValue Present
cash inflows Value
that will be
received over the next four years. Factor at
10%
1 1,000 0.909 909
2 2,000 0.826 1,652
3 3,000 0.751 2,253
4 4,000 0.683 2,732

Present value of series of Cash flows Rs 7,546

 PRESENT VALUE OF AN ANNUITY
1 1- (1+r)n
Present value of an annuity = A r
Value of PVIFAr,n for Various Combinations of r and n
n/r 6 % 8% 10 % 12 % 14 %
2 1.833 1.783 1.737 1.690 1.647
4 3.465 3.312 3.170 3.037 2.914
6 4.917 4.623 4.355 4.111 3.889
8 6.210 5.747 5.335 4.968 4.639
10 7.360 6.710 6.145 5.650 5.216
12 8.384 7.536 6.814 6.194 5.660

 Centre for Financial Management , Bangalore

 Present Value of Annuity
• Illustration: Mr. P. K. Chandra expects Rs. 100 each year for five years. What would be the
present value of investment if interest rate is 5 per cent on his investment.
 Present Value of Annuity
• Illustration: Mr. P. K. Chandra expects Rs. 100 each year for five years. What would be the
present value of investment if interest rate is 5 per cent on his investment.

• The calculation of present value is as follows:

PVn = 100/ (1.05)+ 100/ (1.05)2 + 100/ (1.05)3 + 100/ (1.05)4 + 100/ (1.05)5

= 95.23 + 90.70 + 86.38 + 82.27 + 78.35

= Rs. 432.93
 Present Value: Ordinary Annuity
Suppose you receive Rs.1000 for 3 years, each receipt
occurring at the end of the year. What is the present
value of this stream of benefits if the discount rate is 10
per cent?

PV = FVA x [{1- (1 / 1+r )^n} / r]

PVIFA = [{ 1 –
(1/1+0.10)^3)} / 0.10]

PV=1,000 x PVIFA (10%, 3 years) =

1,000 x 2.4868 = Rs.2486.8
 Present Value: Annuity Due

Mr. Anil Kumar deposits Rs.1,000 at the beginning of

each year for the period of 3 years at the interest rate of
5%. Calculate the present value of Annuity Due.

PV = FVA x [{1- (1 / 1+r )^n} / r] *

(1+r) PVIFA = [{ 1 –
(1/1+0.05)^3)} / 0.05]
*(1+0.05)
PV=1,000 x PVIFA (5%, 3 years) x 1.05 =
1,000 x 2.723 x 1.05 = Rs. 2,859.41
 LOAN AMORTISATION SCHEDULE
Loan : 1,000,000 r = 15%, n = 5 years
1,000,000 = A x PVIFA(15%,5)
= A x 3.3522
A = 298,312

Year Beginning Annual Interest Principal Remaining

Amount Instalment Repayment Balance
(1) (2) (3) (2)-(3) = (4) (1)-(4) = (5)
1 1,000,000 298,312 150,000 148,312 851,688
2 851,688 298,312 127,753 170,559 681,129
3 681,129 298,312 102,169 196,143 484,986
4 484,986 298,312 727,482 225,564 259,422
5 259,422 298,312 38,913 259,399 23*

  a     Interest is calculated by multiplying the beginning loan balance by the interest rate.
b.   Principal repayment is equal to annual instalment minus interest.
* Due to rounding off error a small balance is shown
 Present Value: Perpetuity
Company “Rich” pays Rs.2000 in dividends annually
and estimates that they will pay the dividends
indefinitely. How much are investors willing to pay for
the share with a required rate of return of 5%?

PV = A / r

PV =2,000 x 1/ 0.05

= 40000
 Numerical

• Mr. Bharat, principal, wishes to institute a scholarship of Rs. 5,000 for an

outstanding student every year. He wants to know the present value of
investment which would yield Rs. 5,000 in perpetuity, discounted at 10%.
 SUMMING UP
 Money has time value. A rupee today is more valuable than
a
rupee a year hence.
 The general formula for the future value of a single amount

is :
Future value = Present value (1+r)n
 The value of the compounding factor, (1+r)n, depends on
the
interest rate (r) and the life of the investment (n).
 According to the rule of 72, the doubling period is obtained
by dividing 72 by the interest rate.
 The general formula for the future value of a single cash
 An annuity is a series of periodic cash flows (payments and
receipts) of equal amounts. The future value of an annuity is:
Future value of an annuity
= Constant periodic flow [(1+r)n – 1)/r]
 The process of discounting, used for calculating the present
value, is simply the inverse of compounding. The present
value of a single amount is:
Present value = Future value x 1/(1+r)n
 The present value of an annuity is:
Present value of an annuity
= Constant periodic flow [1 – 1/ (1+r)n] /r
 A perpetuity is an annuity of infinite duration. In general
terms:
Present value of a perpetuity = Constant periodic flow [1/r]