Financial Management

Module I
TIME VALUE OF MONEY
By Preeti Garg
A Bird in hand is better than
two in Bush
A Rupee today is better than a
rupee one year hence
 What is The Time Value of
Money?
• A Rupee today is better than a rupee one
year hence.
– This is because a rupee received today can
be invested to earn interest
– The amount of interest earned depends on
the rate of return that can be earned on the
investment
• Time value of money quantifies the value
of a rupee through time
 Why TIME?

• Why is TIME such an important element in

your decision?
• TIME allows you the opportunity to
postpone consumption and earn
INTEREST.
 Benefits of the knowledge of the time
value of money

• For investment analysis – To decide the financial

benefits of projects
• To compare investment alternatives
• To analyze how time impacts business activities
such as loans, mortgages, leases, savings, and
annuities.
Calculations based on the time value of
money

• Present Value (PV) of an amount that

will be received in the future.
• Future Value (FV) of an amount
invested (such as in a deposit account)
now at a given rate of interest.
• Present Value of an Annuity (PVA)
• Future Value of an Annuity (FVA)
• Compound Interest and simple interest
• SI=P*R*T/100
• Compound Interest
• Amount=principle*(1+rate/100)^time-
principle
• Simple Interest1000*10*3/100=300 1300
• Compound
Interest=1000(1+.10)^3=1331.33
 Future Value of a Sum
• If a sum is invested today, it will earn interest
and increase in value over time. The value that
the sum grows to is known as its future value.
• Computing the future value of a sum is known as
compounding.
• The future value of a sum depends on the
interest rate earned and the time horizon over
which the sum is invested.
• This is shown with the following formula:
FVN = PV(1+r)N
• This is shown with the following formula:
FVN = PV(1+r)N
• where:
• FVN = future value of a sum invested for N
periods
• r = periodic rate of interest
• PV = the present or current value of the
sum invested
 Future Value Calculation
• Consider Option A
• Let’s calculate the future value of Rs.10,000
received at the present time.
– Assume no inflation
– Assume interest rate 10% (Compound Interest)
Future Value Calculation
Time Value Calculations using Tables
• PRESENT VALUE TABLES
• APPENDIX A
• APPENDIX TABLE 1
• Discount factors: Present value of $1 to be
received after t years
• 1/(1+r)t
• t = Number of years
• r = Interest Rate per Year
 Present Value of a Sum
• The present value of a sum is the amount
that would need to be invested today in
order to be worth that sum in the future.
• Computing the present value of a sum is
known as discounting.
• The formula for computing the present
value of a sum is:
 Present Value Calculation
• Similarly using the equation as

the present value of Rs. 10,000 received

in 3 years when the interest rate is 10%
can be calculated as Rs. 7513.1
Time Value of Money
• Common formulas that are used in TVM calculations:*
– Future value of a lump sum:
FVt = CF0 * (1+r)t OR FVt = PV * (1+r)t

– Present value of a lump sum:

PV = CFt / (1+r)t OR PV = FVt / (1+r)t
 Annuities
• An annuity is a periodic stream of equally-sized
payments.
• The two basic types of annuities are:
– ordinary annuity
– annuity due
• With an ordinary annuity, the first payment takes
place one period in the future.
• With an annuity due, the first payment takes
place immediately.
• Present value of an annuity
• How much must be invested today in a bank
account that pays 5% interest per year in order
to generate a stream of payments of $1,000 at
the end of each of the next three years?
• In this case,
N = 3, r = 5, A= $1,000
Example of PV of a Cash Flow
Stream
 Rohan made an investment that will pay $100 the first year,
$300 the second year, $500 the third year and $1000 the
fourth year. If the interest rate is ten percent, what is the
present value of this cash flow stream?
1. Draw a timeline:

$100 $300 $500 $1000

0 1 2 3 4
?
? i = 10%
?
? 21
Example of PV of a Cash Flow
Stream
2. Write out the formula using symbols:
n

PV = S [CFt / (1+r)t]
t=0

OR
PV = [CF1/(1+r)1]+[CF2/(1+r)2]+[CF3/(1+r)3]+[CF4/(1+r)4]

3. Substitute the appropriate numbers:

PV = [100/(1+.1)1]+[$300/(1+.1)2]+[500/(1+.1)3]+[1000/(1.1)4]

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Example of PV of a Cash Flow
Stream
4. Solve for the present value:
PV = $90.91 + $247.93 + $375.66 + $683.01
PV = $1397.51

5. Check using a calculator:

 Make sure to use the appropriate rate of return, number of
periods, and future value for each of the calculations. To
illustrate, for the first cash flow, you should enter FV=100, n=1,
i=10, PMT=0, PV=?. Note that you will have to do four separate
calculations.

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 Future value of an annuity
• The future value of an annuity (FVA) formula has four
variables, each of which can be solved for:

• FV(A) is the value of the annuity at time = n

• A is the value of the individual payments in each
compounding period
• i is the interest rate that would be compounded for each
period of time
• n is the number of payment periods
• To get the FV of an annuity due, multiply the above
equation by (1 + i).
• Suppose that a sum of Rs.1,000 is invested at
the end of each of the next four years at an
annual rate of interest of 3%. What is the future
value of this ordinary annuity?
• In this case,
• N = 4, i = 3, A = Rs.1,000
 Future Value of a Cash Flow
Stream
• The future value of a cash flow stream is
equal to the sum of the future values of the
individual cash flows.
• The FV of a cash flow stream can also be
found by taking the PV of that same
stream and finding the FV of that lump
sum using the appropriate rate of return
for the appropriate number of periods.
 Example of FV of a Cash Flow
Stream
• Assume Joe has the same cash flow stream from his
investment but wants to know what it will be worth at the end
of the fourth year
1. Draw a timeline:

$100 $300 $500 $1000

0 1 2 3 4
$1000
i = 10% ?
?
? 27
 Example of FV of a Cash Flow
Stream
2. Write out the formula using symbols
n

FV = S [CFt * (1+r)n-t]
t=0

OR
FV = [CF1*(1+r)n-1]+[CF2*(1+r)n-2]+[CF3*(1+r)n-3]+[CF4*(1+r)n-4]

3. Substitute the appropriate numbers:

FV = [$100*(1+.1)4-1]+[$300*(1+.1)4-2]+[$500*(1+.1)4-3] +[$1000*(1+.1)4-
4
]

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Example of FV of a Cash Flow
Stream
4. Solve for the Future Value:
FV = $133.10 + $363.00 + $550.00 + $1000
FV = $2046.10

5. Check using the calculator:

– Make sure to use the appropriate interest rate, time period and
present value for each of the four cash flows. To illustrate, for the
first cash flow, you should enter PV=100, n=3, i=10, PMT=0,
FV=?. Note that you will have to do four separate calculations.

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Thank You