TIME VALUE OF MONEY

Financial Management
Prof. Deepa Iyer

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 WHAT IS THE TIME VALUE OF MONEY?

• The time value of money is a basic financial

concept that holds that money in the present is
worth more than the same sum of money to be
received in the future. This is true because money
that you have right now can be invested and earn
a return, thus creating a larger amount of money
in the future.
• The time value of money is sometimes referred to
as the Net Present Value (NPV) of money.

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 FUTURE VALUE OF A SINGLE AMOUNT

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:

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 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

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 FUTURE VALUE OF A SINGLE AMOUNT

• Compound Interest
The process of investing money as well as
reinvesting the interest earned thereon is called
compounding. The future value or compounded
value of an investment after n years when the
interest rate is r percent is:
FVn = PV(1+r)n
FV – Future value n years hence
PV – Present Value
r – Interest rate or discount rate
n – Number of periods over which the cash flows occur
n
(1+r) – Future value interest factor

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 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?

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 FUTURE VALUE OF A SINGLE AMOUNT

• Future value interest factor FVIF(r,n)

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 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

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 FUTURE VALUE OF A SINGLE AMOUNT

• Compound and Simple Interest

When money is invested at compound interest
it means each interest payment is reinvested
to earn further interest in future periods.

By contrast, if no interest is earned on interest

the investment earns only simple interest.

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 FUTURE VALUE OF A SINGLE AMOUNT

• Simple Interest
Future Value = Present value ( 1 + number of
years x interest rate )

Example:
An investment of Rs. 1,000, if invested
@12%p.a. for 5 years become.

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 FUTURE VALUE OF A SINGLE AMOUNT

1,000 (1+5x0.12) = Rs. 1,600

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 FUTURE VALUE OF A SINGLE AMOUNT

• Compound Interest vs. Simple Interest

Value of Rs.1,000 invested at 10% Simple and
Compound Interest
.a.

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 FUTURE VALUE OF A SINGLE AMOUNT

• What Is the Rule of 72?

The Rule of 72 is a rule of thumb-quick and
useful formula that is popularly used to
estimate the number of years required to
double the invested money at a given
annual rate of return.

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 FUTURE VALUE OF A SINGLE AMOUNT

• What Is the Rule of 72?

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 FUTURE VALUE OF A SINGLE AMOUNT

• What Is the Rule of 72?

For example, If the interest rate is 8%, the
doubling period is about 9 years 72/8.

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 FUTURE VALUE OF A SINGLE AMOUNT

• What Is the Rule of 69?

A more accurate rule of thumb is the rule 69.
According to this rule of thumb, the doubling
period is equal to:
0.35 + 69
Interest Rate

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 FUTURE VALUE OF A SINGLE AMOUNT

• What Is the Rule of 69?

For example, an investor finds that he can
earn a 20% return on a property investment,
and wants to know how long it will take to
double his money. The calculation is:
0.35 + (69 / 20) = 3.8 years to double his
money

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 FUTURE VALUE OF A SINGLE AMOUNT

• Finding the Growth Rate

The formula used to calculate future value can
be used to find growth rate.
For example, A company currently has 5,000
employees and this number is expected to
grow by 5% per year. How many employees
will the co. have in 10 years?
5,000 x (1.05) 10 = 5,000 x 1.629 = 8,145

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