Financial Management

• Time Value of Money – FV & PV

• Capital Budgeting Decision –NPV, IRR, PI, PB, ARR
• Cost of Capital – Equity, Debt, etc.
• Capital Structure - Leverage
• Dividend Policy
Time Value of Money
Time Preference of Money

Rs 10000 today

Rs 10010 after one month

Which would your prefer???

Why???
10000 Today because of Time Preference of
Money
 Reasons for Time Preference
• Risk – Chance to lose the money
• Preference for consumption - Inflation
• Investment Opportunities – Not to miss the
chance
 Time Value of Money
• Future Value – Value of Money tomorrow
• Present Value – Value of Money today
 Future Value
• Future value (FV) is the value of an asset at a specified
date in the future based on an assumed rate of growth
• Principal + Interest/Growth

• Eg The maturity amount you receive from a fixed

deposit (lumpsum)
• Eg The maturity amount you receive from an recurring
deposit (Annuity)
 Cash Flows in Future Value
• Single Cash flow or Lump sum Cash flow
• Annuity – Series of cash flows
 Cash Inflow and Cash Outflow
• Cash Inflow – The money come in eg income
• Cash outflow – The money goes out eg
investment
 Future Value of Lump sum
• Single time cash outflow (investment)
• Single time Cash inflow (Returns)
 Future Value of Lump sum
(Single Cash Flow)
Formula for compounding Yearly(without table)
FV = PV*(1+i)n
• FV = Future Value
• PV= Present Value
• i = Interest/Required rate of return/Compound
rate/Opportunity Cost (All per Year)
• n = Time/No of compounding in total Period
 Future Value of Lumpsum in
MS Excel
=FV(Rate,Nper,Pmt,PV,Type)
Rate = Interest rate
Nper = Number of Compounding
Pmt = Annuity (Not applicable for Lumpsum)
PV = Present Value
Type = Cash flow type
1 For Beginning of the year
0 for end of the year
 Problem
Present Value Rate Years Future Value
(Lumpsum)
25000 12% 1
42000 15% 2
15000 9.5% 3
180000 18% 4

Find the Future Value of Lumpsum.

 ANSWER
Present Value Rate Years Future Value
(Lumpsum)
25000 12% 1 28000
42000 15% 2 55545
15000 9.5% 3 19693.99
180000 18% 4 348980
 Problem
Suppose that Rs 10000 is placed in the savings account of the

bank at 5% interest rate per annum. How much shall it grow at

the end of three years?

• How much shall the amount grow if the compounding happens

semi-annually?

• How much shall the amount grow if the compounding happens

quarterly?

• How much shall the amount grow if compounding happens

monthly?
Solution for Yearly compounding
10000*(1+5%)3 = 11576.25

Period Investment Interest Future Value

1 10000 5% 10500

2 10500 5% 11025

3 11025 5% 11576.25
 Solution for Semi-Annual compounding

10000*(1+5%/2)3*2 = 11596.93
• Number of compounding in a year is 2
• Number of years is 3
• Total number of compounding in three years is 6
• Interest Per year in 5%
• So interest in a compounding period is
5%/2 = 2.5%
Cash flows
Solution for Quarterly compounding

10000*(1+5%/4)3*4 = 11607.55
• Number of compounding in a year is 4
• Number of years is 3
• Total number of compounding in three years is
12
• Interest Per year in 5%
• So interest in a compounding period is
5%/4 = 1.25%
 Cash Flows
Period Investment Interest Future Value
1 10000.00 1.25% 10125.00
2 10125.00 1.25% 10251.56
3 10251.56 1.25% 10379.71
4 10379.71 1.25% 10509.45
5 10509.45 1.25% 10640.82
6 10640.82 1.25% 10773.83
7 10773.83 1.25% 10908.50
8 10908.50 1.25% 11044.86
9 11044.86 1.25% 11182.92
10 11182.92 1.25% 11322.71
11 11322.71 1.25% 11464.24
12 11464.24 1.25% 11607.55
 Solution for Monthly compounding
10000*(1+5%/12)3*12 = 11614.72
• Number of compounding in a year is 12
• Number of years is 3
• Total number of compounding in three years is
36
• Interest Per year in 5%
• So interest in a compounding period is
5%/12 = 0.416%
Period Investment Interest Future Value
1 10000.00 0.42% 10041.67
2 10041.67 0.42% 10083.51
3 10083.51 0.42% 10125.52
4 10125.52 0.42% 10167.71
5 10167.71 0.42% 10210.08
6 10210.08 0.42% 10252.62
7 10252.62 0.42% 10295.34
8 10295.34 0.42% 10338.24
9 10338.24 0.42% 10381.31
10 10381.31 0.42% 10424.57
11 10424.57 0.42% 10468.00
12 10468.00 0.42% 10511.62
13 10511.62 0.42% 10555.42
14 10555.42 0.42% 10599.40
15 10599.40 0.42% 10643.56
16 10643.56 0.42% 10687.91
17 10687.91 0.42% 10732.44
18 10732.44 0.42% 10777.16
19 10777.16 0.42% 10822.07
20 10822.07 0.42% 10867.16
21 10867.16 0.42% 10912.44
22 10912.44 0.42% 10957.91
23 10957.91 0.42% 11003.57
24 11003.57 0.42% 11049.41
25 11049.41 0.42% 11095.45
26 11095.45 0.42% 11141.68
27 11141.68 0.42% 11188.11
28 11188.11 0.42% 11234.72
29 11234.72 0.42% 11281.54
30 11281.54 0.42% 11328.54
31 11328.54 0.42% 11375.74
32 11375.74 0.42% 11423.14
33 11423.14 0.42% 11470.74
34 11470.74 0.42% 11518.53
35 11518.53 0.42% 11566.53
36 11566.53 0.42% 11614.72
 Conclusion
Type No of Present Value in Future Value
Compounding Lump sum
Annual 3 10000 11576.25
Semi Annual 6 10000 11596.93
Quarterly 12 10000 11607.55
Monthly 36 10000 11614.72

Future Value increases if the number of compounding increases

 Problems
• Find the future value of Rs 16000 after 5 years if the interest rate
is 6% - 21411.60

• Find the future value of Rs 15823 after 10 years if the interest

rate is 10% - 41040.78

• Find the future value of Rs 4567 after 25 years if compounding

happens semi annually with an interest rate of 12% - 84124.84

• Find the future value of Rs 15863 after 75 years if the

compounding happens monthly with an interest rate of 13.6%
- 402972010.6
 Real Time Examples
https://www.icicibank.com/calculator/fd-calcula
tor.page
Problem with lumpsum and Annuity

Find the future value of the following investment

for 20 years with interest rate 5%.
A lump sum investment of Rs 10lakhs and a
monthly investment of Rs 5000 together.
Problem Solving using factor Table and MS
Excel
 Future Value of Annuity
• Future value of multiple cash flows
• Present value will Annuity (Multiple times but
fixed amount)
• Annuity means uniform amount like insurance
premium, SIP of mutual funds, EMI of loans,
etc
• Future value of annuity eg. Maturity value of
insurance paid, SIP paid, etc..
 Formula
• Without Table
(1+i)n -1 FV = Future Value
FV = A A = Annuity (PV)
i i = Interest rate
n = Number of Years
 Formula
• With Table

FV = A*CVFAn,i
A = Annuity
CVFA = Compound Value Factor of
Annuity
n = Time/No of compounding in total
Period
i = Interest
 Problems
• A firm deposits Rs 5000 at the end of each
year for four years at 6% interest rate. How
much would this annuity accumulate at the
end of four years?
Answer = Rs 21873
• A firm deposits an annuity amount of Rs 5000
at 6% interest rate. How much would this
annuity accumulate at the end of four years,
• If annuity paid semi annually = Rs 44461.82
• If annuity paid Quarterly = Rs 89661.85
• If annuity paid Monthly = Rs 270489.16
 Real Time Example
• https://www.icicibank.com/Personal-Banking/
account-deposit/recurring-deposits/index.pag
e
Problem with lumpsum and Annuity

Find the future value of the following investment

for 20 years with interest rate 5%.
A lump sum investment of Rs 25lakhs and a
monthly investment of Rs 10000 together.
Problem Solving using factor Table and MS Excel
 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
i
 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