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Time Value of Money, Irr, NPV
Time Value of Money, Irr, NPV
Time Value of Money, Irr, NPV
Topics to be Covered..
What is the Time Value of Money? Simple & Compound Interest Future Value Present Value Annuities NPV IRR PAYBACK
Simple Interest
With Simple Interest, you dont earn interest on interest Year 1: 5% of Rs.100 = Rs.5 + Rs.100 = Rs.105
Year 2: 5% of Rs.100 =
Year 3: 5% of Rs.100 =
Year 4: 5% of Rs.100 =
Year 5: 5% of Rs.100 =
Compound Interest
With compound interest, a depositor earns interest on interest! Year 1: 5% of Rs.100.00 = Rs.5.00 + Rs.100.00 = Rs.105.00 Year 2: 5% of Rs.105.00 = Rs.5.25 + Rs.105.00 = Rs.110.25
Future Value
If you invested Rs. 4,000 today in an account that
pays 8% interest, with interest compounded annually, how much will be in the account at the end of two years if there are no withdrawals?
8%
Rs.4,000
FV
= 4000(1+0.08)^2 = Rs.4665.6
Present Value
Assume that you need to have exactly Rs.10,000 saved 10 years from now. How much money must you deposit today in an account that pays 8% interest, compounded annually, so that you reach your goal of Rs.10,000?
8%
10
Rs.10,000
PV0
0
8%
10
Rs.10,000
PV0
Annuities
An Annuity represents a series of equal payments (or receipts) occurring over a specified number of equidistant periods FVA = A (1+i)n 1 i PVA = A 1 - [1/(1+i)n] i
0 7%
1 Rs.1,000
2 Rs.1,000
Rs.3,215 = FVA3
0 7%
1 Rs.1,000
2 Rs.1,000
3 Rs.1,000
Ct=cash inflow in the period t C0=cash outflow of today K=required rate of return T=time period
Example:
This project will have an immediate cash outflow of 100,000. Other cash outflows for years 16 are expected to be 5,000 per year. Cash inflows are expected to be 30,000 each for years 16. And there are no cash flows expected after year 6. The required rate of return is 10%.
Year
T=0 T=1 T=2 T=3 T=4 T=5
Cash flow
-1,00,000/(1.10)0 30,000-5000/(1.10)1 30,000-5000/(1.10)2 30,000-5000/(1.10)3 30,000-5000/(1.10)4
Present value
-1,00,000 22,727 20,661 18,783 17,075 15,523
30,000-5000/(1.10)5
30,000-5000/(1.10)6
T=6
14,112
TOTAL
1,08,881
IRR:
CFt t (1 + IRR)
= IO
YEAR 0 1 2 3 4 5
Cost of capital is 10%
PROJECT A PROJECT B - 1000 - 1000 500 100 400 200 200 200 200 400 100 700
Project A
Project B
Accept if greater than or equal to the required rate of return Reject if less than required rate of return
Payback Period
Year 0 1 2 3 4 5 Cash flow -1000 500 400 200 200 200 Net Cash Flow -1000 - 500 -100 100 300 400
Payback Period Payback Period = 2 + (100)/(200) = 2.5 years