TIME VALUE

OF MONEY
1
CONCEPT
 A rupee, which is received today is more valuable
than a rupee receivable in future. The amount that is
received in earlier period can be reinvested and it can
earn an additional amount.

 Individuals prefer value opportunity to receive money

now rather than waiting for one or more years to
receive the same.

 There are three reasons, that may be attributed to

the individual’s time preference for money:
 Uncertainty
 Current Consumption 2
 Possibility of investment Opportunity
SIMPLE INTEREST
 Simple interest is the interest paid (earned) on the original
amount, or principal borrowed (lent).

 Simple interest is the function of three components such as

principal amount borrowed or lent, interest per annum and
number of years for which the interest rate is calculated.

 Simple interest is calculated as follows:

 SI=P x n x r
 P= Principal amount
 n= No. of years
 r= Rate of interest
 Future value:
3
 FVn=P+SI
COMPOUND INTEREST
 There is a significant difference between simple and
compound interest.

 In simple interest there is no opportunity to earn

interest on interest whereas in compounding interest
each interest payment is reinvested having an
opportunity to earn interest on interest.

 Compound interest is the interest earned on a given

deposit and has become a part of principal at the end
of the specific period.

 Compounding interest is also referred to as future

value. 4
 It can be calculated as follows:
 Annual compounding:
 FVn= P0(1+r)ⁿ
 FVn= Compound Value at the end of “n” year
 P0=Principal amount
 n= No. of years
 r= Rate of interest

 Variable compounding periods

 FVn= P0[1+r/m]m*n
 FVn= Compound Value at the end of “n” year
 P0=Principal amount
 n= No. of years
 r= Rate of interest
5
 m= no. of times compounded in a year.
 Q.1. Suppose you have ₹10,00,000 today and you deposit it with a
financial institute, which pays 8% interest for a period of 5 years.
Show how the deposit would grow:

 If Financial institute gives Simple Interest per annum

 If Financial institute gives Compound Interest per annum

 If Financial institute gives Compound Interest Semi-annually

 If Financial institute gives Compound Interest Quarterly

6
 Q.1. Suppose you have ₹10,00,000 today and you deposit it with a
financial institute, which pays 8% interest for a period of 5 years.
Show how the deposit would grow:

 If Financial institute gives Simple Interest per annum

 Ans: 14,00,000

 If Financial institute gives Compound Interest per annum

 Ans: 1,469,328

 If Financial institute gives Compound Interest Semi-annually

 Ans: 14,80,244

 If Financial institute gives Compound Interest Quarterly

 Ans: 14,85,947

7
 Compounded value of a series of cash flows:
 Uneven Cash flows:

 When investment is done at the end of the year

 FVn=P1(1+r)n-1 +P2(1+r)n-2 +…..+Pn-1(1+r)+Pn

 When investment is done in the beginning of the year

 FVn=P1(1+r)n +P2(1+r)n-1 +…..+Pn-1(1+r)2+Pn (1+r)

 FVn= Compound Value at the end of “n” year

 P1=Payment at the end of year one
 P2=Payment at the end of year two
 Pn=Payment at the end of year n
 n= No. of years
 r= Rate of interest
8
 Q.2. Mr. Shyam deposits ₹ 5,000; ₹ 10,000; ₹ 15,000;
₹ 20,000; and ₹ 25,000 in his savings bank account
at the end of year 1,2,3,4 and 5 respectively.
Interest rate is 6% per annum. He wants to know his
future value of deposit.

9
 Q.2. Mr. Shyam deposits ₹ 5,000; ₹ 10,000; ₹ 15,000;
₹ 20,000; and ₹ 25,000 in his savings bank account
at the end of year 1,2,3,4 and 5 respectively.
Interest rate is 6% per annum. He wants to know his
future value of deposit.
 Sol:

 FVn=P1(1+r) n-1 +P2 (1+r) n-2 +…..+Pn-1(1+r)+Pn

 FVn = 5,000(1.06)4 + 10,000(1.06)3 +15,000(1.06)2 +
20,000(1.06)1 + 25,000

 FVn = 81,276
10
 Q.3. Suppose you deposit in the beginning of each
year ₹ 750, ₹ 1,000, ₹ 1,250, ₹ 1,500 and ₹ 1,750 in
your savings bank account 1 to 5 years respectively.
What are your deposits compound value at the end of
5 years? Interest rate is 6% per annum.

11
 Q.3. Suppose you deposit in the beginning of each
year ₹ 750, ₹ 1,000, ₹ 1,250, ₹ 1,500 and ₹ 1,750 in
your savings bank account 1 to 5 years respectively.
What are your deposits compound value at the end of
5 years? Interest rate is 6% per annum.

 Sol:

 FVn=P1(1+r) n +P2 (1+r) n-1 +…..+Pn-1(1+r)2+Pn (1+r)

 FVn = 750(1.06)5 + 1,000(1.06)4 + 1,250 (1.06)3 +
1,500(1.06)2 + 1,750 (1.06)

 FVn = 7,295
12
ANNUITY
 Even Cash flows:
 Annuity is a series of even cash flows of a fixed
amount for a specified number of years.

 Cash flows may happen either at the end of the

year or beginning of the year.

 If cash flows happen at the beginning of the year,

it is called as an annuity due, whereas when cash
flows happen at the end, it is called as a regular
or deferred annuity.
13
 Compound value of Deferred Annuity:

The formula is arrived at Using Sum of GP:

 FVan= P (1+r)n – 1
r
 Compound value of Annuity Due:

 FVan= P (1+r)n – 1 (1+r)

r

14
 Q.4. Mr. Ram deposits ₹500 at the end of each year
for 6 years at 6% interest. Determine Ram’s money
value at the end of 6 years.

15
 Q.4. Mr. Ram deposits ₹500 at the end of each year
for 6 years at 6 % interest. Determine Ram’s money
value at the end of 6 years

 Sol:

 FVan= P (1+r)n – 1
r
 FVan = 500 {[(1.06)6 – 1]/0.06}

 FVan = 3,488

16
 Q.5. Suppose you deposit ₹ 2,500 at the beginning
of each year for 6 years in a savings bank account
at 8% compound interest. What is your money
value at the end of 6 years?

17
 Q.5. Suppose you deposit ₹ 2,500 at the beginning
of each year for 6 years in a savings bank account
at 8 % compound interest. What is your money
value at the end of 6 years?

 Sol:

 FVan= P (1+r)n – 1 (1+r)

r
 Fvan = 2,500 * 7.92

 FVan = 19,807
18
CONTINUOUS COMPOUNDING
 Value of compounding depends upon its
frequency.

 The value rises exponentially in case of

continuous compounding.

F V n = P x e rt
e  2 .7 1 8 3
PRESENT VALUE
 Present value is exactly contrary to compound value.

 Compound value is helpful to know the interest added

to principal amount at a given compound interest rate
and given number of years, whereas in the present
value is sum that is receivable in the future.

 In simple words, under compounded approach the

sum invested will appreciate whereas in present value
the sum receivable in future will depreciate due to
discounting.

20
 The processes of determining present value of a future
cash flows (inflows and outflows) is called discounting.

 The present value of a future cash flow (inflow/outflow)

is the amount of current cash that is of equivalent
value to the present value.
 It can be calculated as follows:

PV= CIF 1
(1+r)n

 PV= Present Value

 CIF= Cash inflow receivable at the end of “n” year
 n= No. of years
 r= Rate of interest or Discounting rate 21
 Q.6. An investor wants to find out the present value
of ₹ 40,000 due in 3 years if interest rate is 10%
per annum.

22
 Q.6. An investor wants to find out the present value
of ₹ 40,000 due in 3 years if interest rate is 10%
per annum.

 Sol:

PV= CIF 1
(1+r)n

 PVn = 40,000 /(1.10)3

 PVn = 30,053
23
SHORTER DISCOUNTING PERIODS
 Generally, cash flows are discounted once in a
year, but sometimes cash flows have to be
discounted less than one year time, like, semi-
annually, quarterly, monthly or daily.

PV= CIF ____1___

(1+r/m)nm

 PV= Present Value

 CIF = Cash inflow receivable at the end of “n” year
 n= No. of years
 r= Rate of interest or Discounting rate
24
 Q.7. Mr. “A” expected to receive ₹1,00,000 at the end
of 4 years. His required rate of return is 12% per
annum. He wants to know PV of 1,00,000 if it is
quarterly discounting.

25
 Q.7. Mr. “A” expected to receive ₹1,00,000 at the end
of 4 years. His required rate of return is 12% per
annum. He wants to know PV of 1,00,000 if it is
quarterly discounting.

 Sol:

PV= CIF ____1___

(1+r/m)nm

 PVn = 62,317

26
 Present value of a series of cash flows:
 Uneven Cash flows:

 When discounting is done at the end of the year

 PV=CIF 1 + CIF 2 +…..+ CIF n

(1+r)1 (1+r)2 (1+r)n

 When discounting is done in the beginning of the year

 PV= CIF 1 + CIF 2 +…..+ CIF n

(1+r)0 (1+r)1 (1+r)n-1

 PV= Present Value

 CIF= Cash Inflows
 n= No. of years 27
 r= Rate of interest or Discounting rate
o Q.8. From the following information, calculate the present
value of cash inflow at 10% interest rate if amount is received
in the beginning of the year.

Year 0 1 2 3 4 5

Cash inflow 2,000 3,000 4,000 5,000 4,500 5,500

(in ₹)

28
 Q.9. Find the present value of an income stream
which provide ₹500, ₹1,000, ₹1,500, ₹2,000 and
₹2,500 at the end of 1 to 5 years respectively if
interest rate is 12% per annum.

29
PRESENT VALUE OF ANNUITY
 Present value of annuity deferred
 PVan= CIF (1+r)n – 1

r (1+r)n

 Present value of annuity due

 PVan= CIF (1+r)n – 1 (1+r)

r (1+r)n

30
 Q.10. Mr. Ram wishes to determine the PV of the
annuity consisting of cash flows of ₹ 40,000 per
annum for 6 years. The rate interest he can earn
from his investment is 10%.

31
 Q.10. Mr. Ram wishes to determine the PV of the
annuity consisting of cash flows of ₹ 40,000 per
annum for 6 years. The rate interest he can earn
from his investment is 10%.

 Sol:

 PVan= CIF (1+r)n – 1

r (1+r)n

 PVan = 1,74,210

32
 Q.11. Mr. Krishna has to receive ₹ 500 at the
beginning of each year for 4 years. Calculate
present value of annuity due assuming 10% rate of
interest.

33
 Q.11. Mr. Krishna has to receive ₹ 500 at the
beginning of each year for 4 years. Calculate
present value of annuity due assuming 10% rate of
interest.

 Sol:

 PVan= CIF (1+r)n – 1 (1+r)

r (1+r)n

PVan = 1,743

34
PRESENT VALUE OF GROWING
ANNUITY
 Growing annuity means the cash flows that
grows at a constant rate for a specified period of
time.
 Present value of growing annuity deferred:

 1-

 Present value of growing annuity due:

 1- (1+r) 35
 Q.12. XYZ Real Estate Agency has rented out one of
their apartments for 5 years at an annual rent of ₹
6,00,000 with the stipulation that rent will increase
by 5% every year. If the agency’s required rate of
return is 14%, what is the PV of expected (annuity)
rent.

36
 Q.12. XYZ Real Estate Agency has rented out one of
their apartments for 5 years at an annual rent of ₹
6,00,000 with the stipulation that rent will increase
by 5% every year. If the agency’s required rate of
return is 14%, what is the PV of expected (annuity)
rent.
 Sol: Assuming rent is received in advance we are
using present value of growing Annuity due formula

 1- (1+r)

 CIF = 6,00,000; r =14%; g = 5%, n = 5 years

37
 PV = 25,62,259
Year CIF CIF PVIF (r =14%) PV

1 600000(1+g)^0 600000 1 600000

2 600000(1+g)^1 630000 0.877 552632

3 600000(1+g)^2 661500 0.769 509003

4 600000(1+g)^3 694575 0.675 468818

5 600000(1+g)^4 729303.8 0.592 431806

25,62,259

38
CONTINUOUS DISCOUNTING
 Valueof discounting depends upon its
frequency.

 Thevalue falls exponentially in case of

continuous discounting.
1
PV= FV x rt = FV x e -rt
e
e  2.7183
39
PRESENT VALUE OF PERPETUITY
 Perpetuity is an annuity of infinite duration.

PV = CIF
r

PV = Present value of perpetuity

CIF = Constant cash inflow
r = Rate of interest or Discounting rate

40
Q.13. Mr. “A” an investor expects a perpetual
amount of ₹ 1,000 annually from his investment.
What is the present value of perpetuity if the
interest rate being 8%?

41
Q.13. Mr. “A” an investor expects a perpetual
amount of ₹ 1,000 annually from his investment.
What is the present value of perpetuity if the
interest rate being 8%?
 Sol:

PV∞ = CIF
r
 PV = 1,000 / 0.08

 PV = 12,500

42
PRESENT VALUE OF GROWING
PERPETUITY
 It assumes that the cash flows (dividends) associated with the
certain investments (stocks) are known in the first period and
will grow at a constant compound rate in subsequent periods.

 More generally, this is growing perpetuity:

PVg  = CIF_
r-g

 The growing perpetuity expression simply subtracts the growth

rate from the discount rate; the growth in cash flows helps to
“cover” the time value of money.

 This formula for evaluating growing perpetuities can be used

only when r > g.
43
Q.14. If a stock is paying dividend of 100 in year one
and is expected to increase its dividend payment by
10% each year thereafter. What is the present value of
perpetuity if discounting rate13%?

44
Q.14. If a stock is paying dividend of 100 in year one
and is expected to increase its dividend payment by
10% each year thereafter. What is the present value of
perpetuity if discounting rate13%?

 Sol:

 PVg∞ = CIF / r – g

 CIF = 100, g = 10%, r = 13%

 PVg∞ = 100 / 0.13- 0.10

 PVg∞ = 3,333 45
LOAN INSTALLMENT AND
AMORTIZATION

 Loan is an amount raised from outsiders on an

interest and repayable at a specific period (lump sum
or in installments)
 Payment of loan is known as amortization.

 PA

LI= Loan installment

PA= Principle amount borrowed
r = Rate of interest or Discounting rate 46
Q.15. ABC company raised ₹ 10,00,000 for an
expansion program from IDBI bank at 7% per annum.
The amount to be repaid in 6 equal annual
installments. Calculate loan installment amount and
also prepare loan amortization schedule.

47
Q.15. ABC company raised ₹ 10,00,000 for an
expansion programme from IDBI bank at 7% per
annum. The amount to be repaid in 6 equal annual
installments. Calculate loan installment amount and
also prepare loan amortization schedule.

 Sol: PA = 10,00,000; r = 7%, n = 6 years

 PA
 LI = 2,09,796

48
LOAN AMORTIZATION SCHEDULE

Year Principal in the LI Interest Principal Principal

beginning of the Balance at the
year end of the year
1 1000000 209796 70000 139796 860204
2 860204 209796 60214 149582 710622
3 710622 209796 49744 160052 550570
4 550570 209796 38540 171256 379314
5 379314 209796 26552 183244 196070
6 196070 209796 13726 196070 0

49
EMI
 EMI (Equated monthly installment) refers to as the
monthly payment towards interest and principal
amount by the borrower to the lender.

 EMI is calculated using a formula that considers loan

amount, interest rate and loan period as variable.

 EMI = PA r/12 (1+r/12)n12

(1+r/12)n*12 – 1

50
Q.16. Assuming a loan amount of ₹ 1,00, 000, at 9% to
be repaid in 5 years, calculate EMI (Equated monthly
installments)

51
Q.16. Assuming a loan amount of ₹ 1,00, 000, at 9% to
be repaid in 5 years, calculate EMI (Equated monthly
installments)
 Sol:

 PA = 1,00,000; r = 9%, n = 5 m =12

 EMI = PA r/12 (1+r/12)n12

(1+r/12)n*12 – 1

 EMI = 2076

52
SINKING FUND FACTOR
 Financial manager may need to estimate the
amount of annual payments so as to accumulate
a predetermined amount after future date to
purchase assets or to pay a liability.

 P = FVan r
_______ _______

(1+r)n – 1

53
Q.17. ABC ltd. has 10,00,000 bonds outstanding.
Bank deposits earn 10% p. a. The bonds will be
redeemed after 15years for which ABC ltd wishes to
create a sinking fund. How much amount should be
deposited to the sinking fund each year so that ABC
should have amount to retire its entire issue of bonds.

54
Q.17. ABC ltd. has 10,00,000 bonds outstanding.
Bank deposits earn 10% p. a. The bonds will be
redeemed after 15years for which ABC ltd wishes to
create a sinking fund. How much amount should be
deposited to the sinking fund each year so that ABC
should have amount to retire its entire issue of bonds.
 Sol:

 FVan = 10,00,000; r = 10%; n = 15 years

 P = FVan r
_______ _______

(1+r)n – 1
 P = 31,474
55
Q.19. An executive is about to retire at the age of 60.
His employer has offered him two post retirement
plans. (a)20,00,000 lump sum, (b)2,50,000 each year
for 10 years. Assume 10% interest rate, suggest which
is a better option?

56
Q.20. As winner of a competition, you can choose one of
the following prizes if the interest rate is 12%, which is
the most valuable prize?
a. ₹100,000 now
b. ₹180,000 at the end of fifth year
c. ₹11,400 per year forever.
d. ₹19,000 each year for 10 years
e. ₹ 5000 in year one and rising thereafter by 5% per year
forever.

57
EFFECTIVE VS. NOMINAL RATE
 Nominal rate is the rate of interest per year

 Effective and Nominal rate are equal only when

the compounding is done yearly once, but there
will be a difference, that effective rate is greater
than the nominal rate for shorter compounding
periods.

 ERI = (1+r/m)mn -1

58
Q.18. Assume the rate of interest is 12%. Compute the
annual percentage/effective rate if interest is paid
(a)annually (b)semi-annually (c)quarterly (d)monthly

59
Q.18. Assume the rate of interest is 12%. Compute the
annual percentage/effective rate if interest is paid
(a)annually (b)semi-annually (c)quarterly (d)monthly
 Sol:

 ERI = (1+r/m)mn -1

 (a)annually = ERI = 12%

 (b)semi-annually = ERI = 12.36%

 (c)quarterly = ERI = 12.55%

 (d)monthly = ERI = 12.68%

60
DOUBLING PERIOD AND EFFECTIVE
RATE OF INTEREST IN DOUBLING
PERIOD

 Rule of 72:
 Dp = 72 ÷ r

 ERI = 72 ÷ Dp

 Rule of 69:
 Dp = 0.35 + 69 ÷ r

 ERI = 0.35 + 69 ÷ Dp
61
COMPOUND GROWTH RATE
 Compound growth rate can be calculated as follows:

 g: V0(1+r)n =Vn
 g: = Growth rate in percentage

 V = Variable for which the growth rate is needed to be found

 V0 = Variable value at the end of the year 0

 Vn = Variable value at the end of year n

62
Q.21. From the following dividend data of a company
calculate compound rate of growth for period 2014-2019.

Year 2014 2015 2016 2017 2018 2019

DPS 21 22 25 26 28 31

63
Q.22. An investor is 50 years of age today. He will
retire at the age of 60. In order to receive Rs.2,00,000
annually for 10 years after retirement, how much
amount should he have at the time of retirement?
Assume the required rate of return is 10%.

64
Q.23. Exactly 10 years from now Shri Chand will start
receiving a pension of Rs.3,000 a year. The payment
will continue for sixteen years. How much is the
pension worth now, if Shri Chand’s interest rate is
10%?

65
Q.24. Sagar wishes to accumulate Rs.80,00,000 by the
end of 5 years by making equal annual year-end
deposits over next 5 years for his son’s higher studies.
Assuming 7% rate of return, how much he should
deposit at the end of each year to accumulate this
amount?

66
 Q.25. Mohan bought a share 15 years ago for Rs. 10.
It is now selling for 27.60. What is the compound
growth rate in the price of the share?

67
Q.26. As a winner of a competition, you can choose one
of the following prizes:
 Rs. 800,000 now

 Rs. 20,00,000 at the end of 8th year

 Rs. 1,00,000 a year forever

 Rs. 1,30,000 per year for 12 years

If the interest rate is 12 percent, which prize has the

highest present value?

68
 Q.27. Harris has just bought a scratch lottery
ticket and won Rs 100,000. He wants to finance
the future study of his newly born daughter and
invests this money in a fund with a maturity of
18 years offering a promising yearly return of 6%.
What is the amount available on the 18th
birthday of his daughter?

 Q.28. Patole considers buying a house.

Currently, he pays a rent for Rs 50,000 a month.
The current monthly interest rate on home loan
is 0.5%. His planning period is 20 years. If he
doesn’t want to increase his housing costs, what
amount of loan is available for his purchase?
69
Q.29. IDFC bank is advertising that if you deposit Rs
2,00,000 with them, and leave it there for 60 months,
you can get Rs 4,00,000 back at the end of this period.
Assuming monthly compounding, what is the monthly
rate of interest paid by the bank?

Q.30. Amol wishes to retire 20 years from now and

expects to live for 15 years thereafter. He wishes to have
a yearly pension of Rs. 2,00,000 for 15 years he will live
after retirement. He wants the pension to start one year
after retirement. If the interest rate is 8% and expected
to remain same, what lump sum amount should Amol
set aside today to facilitate this?

70
EXCEL FUNCTIONS
Parameter Symbol Built in formula in excel

Present value PV =PV(rate, nper, pmt, [fv], [type])

FV (if omitted—it’s assumed to be 0 and PMT must
be included)
Type : When payments are made (0, or if omitted—
assumed to be at the end of the period, or 1—assumed
to be at the beginning of the period)

Future Value FV =FV(rate,nper,pmt,pv,type)

No of continuous successive Periods NPER =NPer(rate, pmt, pv, fv, type)

Payment per period PMT =PMT(rate,nper,pv,[fv],[type])

Interest rate RATE =Rate(nper,pmt,pv,fv,type,guess)

http://www.tvmcalcs.com/index.php/calculators/excel_tvm_functions/excel_tvm 71
_functions_page1