TIME VALUE OF MONEY

FINANCIAL MANAGEMENT
Why money has time value?
1. Inflation
2. Earning Power of Money
3. Uncertainty
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑆𝑖𝑛𝑔𝑙𝑒 𝐴𝑚𝑜𝑢𝑛𝑡
(𝐹𝑉 ) = 𝑃𝑉 × (1 + 𝑟)𝑛
FV= Future Value
PV = Present Value
r= Interest rate/return
n= number of periods/years

Example: If you deposit Rs. 1000 in a bank at a rate

of 10% p.a. for 10 years, what will you get after 10
years?
ANS (𝐹𝑉 ) = 𝑃𝑉 × (1 + 𝑟)𝑛
(𝐹𝑉 ) = 1000 × (1 + 0.10)10 = 𝑅𝑠. 2593.7
  𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑆𝑖𝑛𝑔𝑙𝑒 𝐴𝑚𝑜𝑢𝑛𝑡
(𝑃𝑉 ) = 𝐹𝑉 ÷ (1 + 𝑟)𝑛
(𝑃𝑉 ) = 𝐹𝑉 ÷ (1 + 𝑟)𝑛
Example: You are going to receive Rs. 2000000
after 30 years. What is the present value today if
the rate of interest in the market is 10%
ANS
FV= Future Value=2000000
PV = Present Value=?
r= Interest rate/return= 10%
n= number of periods=30 years
(𝑃𝑉 ) = 𝐹𝑉 ÷ (1 + 𝑟)𝑛
(𝑃𝑉 ) = 2000000 ÷ (1 + .1)30
=Rs. 114617

Example: You are given two options; Rs. 100 today

or Rs. 150 after 4 years. If the rate of interest in
bank is 9%, which option will you select?
ANS: PV of second option=150/(1.09)^4= 106.3
which is higher than first option(Rs.100) therefore
option-2 is better
 𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐴𝑛𝑛𝑢𝑖𝑡𝑦
(1 + 𝑟)𝑛 − 1
(𝐹𝑉𝐴) = 𝐴 { }
𝑟
(1 + 𝑟)𝑛 − 1
(𝐹𝑉𝐴) = 𝐴 { }
𝑟
Example: What will you get after 7 years if you
deposit Rs. 10000 every year at a rate of 10% p.a..
ANS:
FVA=Future Value of Annuity
A= Annuity=10000
R=rate of interest/return=.10
N=no. of periods=7
(1 + .1)7 − 1
(𝐹𝑉𝐴) = 10000 { } = 𝑅𝑠. 94871
0.1
Example: You will need Rs. 1000000 after 5 years.
What amount you must deposit in a bank account
for next 5 years in order to get Rs. 1000000 after 5
years? The bank offers 10% interest.
ANS:
FVA=Future Value of Annuity (Given)= Rs. 1000000
A= Annuity(Missing)=?
R=rate of interest/return=10%=0.10
N=no. of periods=5
(1 + 𝑟 )𝑛 − 1
(𝐹𝑉𝐴) = 𝐴 { }
𝑟
(1 + 0.10)5 − 1
1000000 = 𝐴 { } 𝐴 = 𝑅𝑠. 163797 𝑒𝑣𝑒𝑦 𝑦𝑒𝑎𝑟
0.10
 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐴𝑛𝑛𝑢𝑖𝑡𝑦
(1 + 𝑟)𝑛 − 1
(𝑃𝑉𝐴) = 𝐴 { 𝑛 }
𝑟 × (1 + 𝑟)
(1 + 𝑟)𝑛 − 1
(𝑃𝑉𝐴) = 𝐴 { 𝑛 }
𝑟 × (1 + 𝑟)
Example:
What loan amount you can avail today if you are
able to pay an instalment of Rs. 300000 p.a. for
next 4 years. Assume that the rate of interest is
10% p.a.
ANS
Annuity=Maximum instalment you can pay=300000 p.a.=A
How many years = 4 yrs=n
Rate of interest =10%=r
Present Value of Annuity= What loan amount can you
get?=PVA

(1 + .1)4 − 1
(𝑃𝑉𝐴) = 300000 { 4 }
. 1 × (1 + .1)
Rule of 72
It talks about doubling period. Money gets double in 72/r
years(where r is the rate of interest)
Assume that the rate of interest is 10% therefore money will
get double in 72/10=7.2 yrs

𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐺𝑟𝑜𝑤𝑖𝑛𝑔 𝐴𝑛𝑛𝑢𝑖𝑡𝑦

1+𝑔 𝑛
1−( )
= 𝐴1 × { 1 + 𝑟 }
𝑟−𝑔

𝑊ℎ𝑒𝑟𝑒 𝐴1 = 𝐴0 × (1 + 𝑔)

Example: (Recall the example of car accident,

discussed in the class)
ANS
Current salary=A0=Rs.1000000 p.a.
G= growth Rate =10%=0.1
A1=Annuity next year= 1100000
R=Discount Rate= 12%=0.12
N=Time period=remaining earning life=30 years
What is the value of the person’s life time earnings
1+0.1 30
1− ( )
1+.12
1000000𝑋(1.10) { 0.12−0.11
}=8.70 CR
Example:- (Recall the Mining Example)
Current Production=1000 units
Current Price= Rs. 100
A0=100000 A1=100000 X (1.06)=110000
Number of years = 10
Growth in price = 6% p.a.
r=10%
What price can be paid for the mining rights?
1+0.06 10
1− ( )
1+.10
100000𝑋(1.06) { 0.10−0.06
}=Rs. 820309

Present Value of Perpetuity

PV= P/r
10000=1000/0.10

Present Value of Growing Perpetuity

PV= P1/(r-g) = P0 X(1+g)/(r-g)

10000=1000/0.10
Annuity Due
PV FV
Year 0 1 2 3 4 5
Normal Annuity A A A A A

PV FV
Year 0 1 2 3 4 5
Annuity Due A A A A A

IN CASE OF ANNUITY DUE, THE ANSWER IS TO BE

MULTIPLIED WITH (1+R), For Ex.:
𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐴𝑛𝑛𝑢𝑖𝑡𝑦 𝐷𝑢𝑒
(1 + 𝑟)𝑛 − 1
(𝐹𝑉𝐴) = 𝐴 { } × (1 + 𝑟)
𝑟
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐴𝑛𝑛𝑢𝑖𝑡𝑦 𝐷𝑢𝑒
(1 + 𝑟)𝑛 − 1
(𝑃𝑉𝐴) = 𝐴 { 𝑛 } × (1 + 𝑟)
𝑟 × (1 + 𝑟)

Effective Vs. Stated rate

Real Vs. Nominal Rate

(1+r)n-1
Present Value of Annuity= AX
r X (1+r)n
 (1+r)n-1
Future Value of Annuity= AX
r

Practice Problems
1. You can save Rs. 3000 a year for 5 years and Rs.
8000 a year for 10 years thereafter. What will
these savings cumulate to at the end of 15
years, if the interest rate is 10% p.a.?
(1+r)n-1
Future Value of Annuity= AX
r

=3000 X FVA Eq. X (1+r)^10 + 8000 X FVA

Eq.=Rs.1,75,000
2. Mr. Mehta plans to send his son for higher
education after 8 years. He expects the cost of
these studies to be Rs. 20,00,000. How much
should he save annually to meet the
requirement? Assume rate of 8% p.a.

FVA = A X {(1+r)n-1}/{r}
20,00,000 = A X {(1+0.08)8-1}/{0.08} = 188029
3. At the time of retirement, Mr. Shah is given
two options; (i) An annual payment of
Rs.200000 as long as he lives,
(ii) A lumpsum amount Rs. 20,00,000 today. If
Mr. Shah expects to live for 15 years and the
interest rate is 8%, which option should he
choose?
ANS: Compute the present value of annuity of
Option-1 and compare it with the second one
Present value of Option-I [A= 200000 pa, r= 8%,
n=15]
PVA = A X {(1+r)n – 1}/{r X (1+r)n}
PVA = 200000 X {(1.08)15 – 1}/{0.08 X (1.08)15}
=1711895 (Present value of Option-1)
17,11,895 < 20,00,000, option-2 is better
4. Ms. Janki deposits Rs. 50,00,000 in a bank that
pays 10% interest. How much can she
withdraw annually for a period of 20 years.
Assume that after 20 years the account
balance will become zero
PVA=5000000, r=0.1, n=20yrs

PVA = A X {(1+r)n – 1}/{r X (1+r)n}

5000000 = A X {(1.1)20 – 1}/{0.10 X (1.10)20}
A = Rs. 587298
 5. What is the present value of an income stream
that provides Rs. 1,00,000 at the end of each of
year 1 through year-3, Rs. 3,00,000 at the end
of each of year 4 through year-6 and Rs.
5,00,000 every year, forever thereafter? The
interest rate is 10%.
=100000X{(1.1)3 -1}/{r x (1.13)}
Plus 300000X{(1.1)3 -1}/{r x 1.13} X
1/(1.10)3
Plus {500000/0.10} /1.106

Year Cash Flow Present Value Present Value

1 100000 100000/(1.1)^1 90909.09091
2 100000 100000/(1.1)^2 82644.6281
3 100000 100000/(1.1)^3 75131.48009
4 300000 300000/(1.1)^4 204904.0366
5 300000 300000/(1.1)^5 186276.3969
6 300000 300000/(1.1)^6 169342.179
Present Value of the cash flows to be received
809208 during first 6 years
7TH YR ONWARDS Rs. 500000
every year

500000/0.1 Why? Present value of perp amt = Amt/r

5000000 This will be the present value after 6 years
why?
because the cash flow will begin from the end of
year 7
Total Present Value= What is the pv today?
3631577 =50,00,000/1.1^6
2822369
6. What amount must be deposited today in
order to earn an annual income of Rs. 2,00,000
starting from the end of 12 years from now and
continuing for 10 years thereafter? The deposit
earns 10 percent per year.
ANS
The present value of annuity after 11 years
=200000 X {(1.1)10 -1}/{1.110 X 0.10}=1228913
So what is the present value today?
Present value after 11 years divided by (1+r)11
=1228913/(1.10)^11=430726
7. If the interest rate is 10 percent how much
investment is required now to yield an income
of Rs.1,00,000 per year from the beginning of
the 10th year and continuing thereafter
forever?
Present value of perp. after 8
years=100000/0.1=rs. 10,00,000
The PV of any cash flow stream is one year before
the starting date
So, What is the PV TODAY?
PV Today = PV after 8th year/(1.1)8
=10,00,000/1.18 = Rs.466507
 8. How much should be deposited at the
beginning of each year for 5 years in order to
provide a sum of Rs. 200000 at the end of 5
years ? The rate is 10%
Ans: 29781 (32759 is wrong)
200000 = A X {(1.15 -1)/(0.1X1.15)} X 1.1
A= 29781
9. A person requires Rs. 90000 at the end of each
year from 2031 to 2037. How much should he
deposit at the end of each year from 2021 to
2026? The interest rate is 12 percent.
Year
0 2020
1 2021 A? Apply the concept of future value of
2 2022 A? annuity to compute A (32165)
3 2023 A? [FVA=y, r=12%, n=6
4 2024 A?
5 2025 A?
6 2026 A? What amount is needed here?(y)
Y(261031) is the present value of x
7 2027
(r=12%, n=4)
8 2028
9 2029
10 2030 What amount is needed here? (x)
X(410738) is the present value of 90000
11 2031 90000
annuity(r=12%, n=7)
12 2032 90000
13 2033 90000
14 2034 90000
15 2035 90000
16 2036 90000
17 2037 90000
10. A person requires Rs. 90000 at the
beginning of each year from 2031 to 2037.
How much should he deposit at the end of
each year from 2021 to 2026? The interest rate
is 12 percent.