TIME VALUE OF MONEY (TMV)

TMV refers to “time has got a value’. The rupee value keeps on changing over a period
of time.

The concept TMV refers to the money received today is different in its worth from the
money receivable at some other time in future.

In other words, TMV is its rate of return which the firm can earn by reinvesting its
present money.

Reasons for time preference for money

1) Risk
2) Inflation
3) Present consumption and satisfaction.
There are two techniques of calculation of TMV
1) Compounding technique: Future Value
2) Discounting technique: Present Value

Compounding technique is used to find out the future value of present money.
Here the interest earned in preceding year is reinvested at prevailing rate of interest for
the next period.
The compounding technique is to find out Future Value of present worth of can be
explained in 3 ways.
3) Future Value of Single Cash Flow
4) Future Value of Annuity/Series of Cash Flows
5) Future Value of Multiple Cash Flows.
Future value (FV) of single present cash flow can be:
a) In case of Annual Compounding
Problem 1
Calculate the FV of Rs. 2000, if it is invested @ 8% interest per year
Formula is FV=PV(1+r)n
Where FV=Future Value
PV=Present Value
r= Rate of interest
n= Number of years
Solution
FV=? FV=2000(1+0.08)1
PV=Rs.2000 =2000(1.08)1
r=8% or 0.08 =Rs.2160
n= 1 year
Problem 2
Calculate the compounding value of Rs. 4000 if it is invested at 12% for two years.

Problem 3
Calculate the future sum of money if it is invested at 10% for four years of Rs. 25000

Problem 4
Arun deposits Rs. 10000 in a bank which pays 8% interest compounded annually for 8
years. Calculate the amount
To be received after 8 years.
b) In case of multiple compounding
In this method if the compounding period varies, interest earned will also vary, viz., if the
Interest Is compounded semi-annually (2), quarterly (4) or monthly (12), such future value is
calculated by using the Following formula

Where, FV=Future Value

(
mn

)
i PV=Present Value
FV=PV 1+ m i=Rate of Interest
m=number of times interest is compounded in a year
n=Number of years
Problem 1 on Multiple Compunding
Calculate the future value of sum of Rs. 2000 if it is invested for a year with compounding
period of semi annually at 10%.

Solution
FV = ?

( )
0.1 2X1
PV=2000 FV=2000 1+ 2
i=10% or 0.1
m=2 =2000(1+0.05)2
n=1 =2000(1.05)2
=2000(1.1025)
FV=2205
Problem 3 on Multiple Compounding
Calculate the Future Value of Rs. 1000 if it is invested for 1 year with a compounding
period of quarterly
At 10%

Problem 4 on Multiple Compounding

National bank pays 10% interest compounded half yearly, if Rs. 100000 is deposited
initially how much
It shall grow at the end of 5th year?

Problem 5 on Multiple Compounding

Indian bank pays 12% interest compounded quarterly, if Rs. 1000 is made as an initial
deposit, how much
It will be at end of 5th year.
Future Value of Annuity of Cash flows (Series of Equal cash flows)

Annuity is even cashflows of a certain period of time

Annuity is fixed payment each year for a specified number of years.

Formula= FVA=R(1+i)n-1 + R(1+i)n-2 + R(1+i)n-3 ……………………………

Where, FVA=Future Value of Annuity

R=Even cash flows
i=interest rate
n= number of years.
Problem 1
Calculate the FVA of Rs. 4000 deposited at end of each year at 6% for a period of 5 years.

FVA=R(1+i)n-1 + R(1+i)n-2 + R(1+i)n-3 + R(1+i)n-4 + R(1+i)n-5

=4000(1+0.06)5-1+4000(1+0.06)5-2+4000(1+0.06)5-3+4000(1+0.06)5-4+4000(1+0.06)5-5
=4000(1.06)4+4000(1.06)3+4000(1.06)2+4000(1.06)1+4000(1.06)0
=4000(1.262)+4000(1.191)+4000(1.123)+4000(1.06)+4000(1)
=5048+4764+4494+4240+4000
FVA=22,546

Problem 2
Kumar deposits Rs.6000 at the end of every year for 5 years and the deposit earns
compound interest @ 12% per annum. Calculate how much money he will have
at the end of five years.
Future Value of Annuity of Cash flows (Series of Equal cash flows)

Annuity is even cashflows of a certain period of time

Annuity is fixed payment each year for a specified number of years.

Formula= FVA=R(1+i)n-1 + R(1+i)n-2 + R(1+i)n-3 ……………………………

Where, FVA=Future Value of Annuity

R=Even cash flows
i=interest rate
n= number of years.
Problem 1 on Future Value of Even cash flows
Calculate the FVA of Rs. 4000 deposited at end of each year at 6% for a period of 5 years.

FVA=R(1+i)n-1 + R(1+i)n-2 + R(1+i)n-3 + R(1+i)n-4 + R(1+i)n-5

=4000(1+0.06)5-1+4000(1+0.06)5-2+4000(1+0.06)5-3+4000(1+0.06)5-4+4000(1+0.06)5-5
=4000(1.06)4+4000(1.06)3+4000(1.06)2+4000(1.06)1+4000(1.06)0
=4000(1.262)+4000(1.191)+4000(1.123)+4000(1.06)+4000(1)
=5048+4764+4494+4240+4000
FVA=22,546

Problem 2 on Future Value of Even cash flows

Kumar deposits Rs.6000 at the end of every year for 5 years and the deposit earns
compound interest @ 12% per annum. Caluculate how much money he will have
at the end of five years.
 FUTURE VALUE OF UNEVEN CASH FLOWS
Formula R1(1+i)n-1+R2(1+i)n-2+R3(1+i)n-3……………………………………………
Where, R1, R2, R3……….uneven cash flows
i = Interest rate
n = Number of years.

Problem 1 on Future Value of Uneven cash flows

Calculate FV of the following cash flows, if it invested at 8% interest per annum.

Year Amount deposited

1 500
2 1000
3 1500
4 2000
5 2500
Solution
FVUECF=R1(1+i)n-1+R2(1+i)n-2+R3(1+i)n-3+R4(1+i)n-4+R5(1+i)n-5

=500(1+0.08)5-1+1000(1+0.08)5-2+1500(1+0.08)5-3+2000(1+0.08)5-4+2500(1+0.08)5-5

=500(1.08)4+1000(1.08)3+1500(1.08)2+2000(1.08)1+2500(1.08)0

=500(1.36)+1000(1.26)+1500(1.17)+2000(1.08)+2500(1)

=680+1260+1750+2160+2500

Rs.8355
Problem 2 on Future Value of Uneven cash flows
Calculate the future value at the end of five years of the following series of payment
at 9% interest per annum
Year Amount deposited
1 1000
2 2000
3 3000
4 4000
5 5000 Answer Rs.16920
Problem 3 on Future Value of Uneven cash flows
Calculate the future value at the end of five years of the following series of payment at 10%
Interest per year.
Year Amount deposited
1 2000
2 2500
3 3000
4 3500
5 4000 Answer 17725
 Discounting Technique or Present Value technique
This method is reverse of compounding technique.
This method helps to find out the present value of future money.

I method – Present Value of Single Cash Flows

Problem 1 on present value of single cash flows
Find out the PV of Rs. 3000 received at the end of a year, if the discount rate is 9%
Solution 3000
=
P1 or FV (1+0.09)1
Formula PV=(1+r)
n

3000
=
Where, FV or P1=future value 1.09
r=discount rate
n= number of years = 2752.29
Problem 2 on Present Value of single cash flow
Calculate the PV of Rs.6000 received after 8 years, if the discount rate is 10%

Problem 3 on Present Value of single cash flow

Calculate the PV of a sum of Rs. 50000 received after 2 years, if the discount rate is 8%
 Calculation of Present Value in case of Multiple Compounding

WHERE, PV=Present Value

P1 or FV P1 or FV=Future Value

(
( mn r = Discount Rate
FORMULA = PV = 1+ r n = Number of years
m m = Number of times discount is compounded
Problem 1 on Present Value of Multiple Compounding

Find out the Present Value of Rs.10,000 receivble after 3 years at the rate of 12% interest.
Calculate semi-annually.
P1 or FV
FORMULA = PV =

(
Solution
1+
r
( mn

m
PV = ?
FV = Rs.10,000
r = 12% or 0.012
m=2
n=3
Problem 3 on Present Value on Multiple Compounding

Calculate the Present Value of Rs. 12,000 receivable after 4 years at the rate of 12%
Interest compounded quarterly.

Problem 4 on Present Value on Multiple Compounding

What is the Present Value of Rs.10,000 receivable after 3 years at the rate of 10%
Interest. Calculate semi annually.
 PAY BACK PERIOD
The Pay Back Period is a capital budgeting technique based on establishing how
long it takes to recover the initial investment from the cumulative cash flows.

Pay Back Period can be calculated in two ways

1) Non Discounted Pay Back
2)Discounted Pay Back

Problem1 on Non Discounted Pay Back

A project requires Rs.20000 initial investment. It generates cash flows of Rs. 8000,
7000, 4000, and 3000 during 4 years. Calculate payback period.

Uncovered amount
Formula = Years before full recovery +
Next year cash flow
Solution
First step: prepare cumulative cash flow
Year cash flow cumulative cash flow
1 8000 8000
2 7000 15000
3 4000 19000
4 3000 22000
In the cumulative total it can be noted that 3years + requires for payback period
1000
Hence 3 years + Uncovered amount (20000-19000=1000) = 3+
3000
3000 (cash flow of next year) = 0.33
Hence the payback period is
3.33 years
Problem 2 (Non discounted Pay Back period)
Calculate pay back period for two machines. Each machine requires an investment of
Rs.50000
MACHINE X MACHINE Y
YEAR CASH FLOWS CASH FLOWS
1 25000 15000
2 30000 25000
3 35000 30000
4 25000 40000
5 20000 30000
Problem 3 (Non discounted Pay back period)

Nagarjuna Engineers intend investing Rs.2,00,000 each in 3 projects. Calculate

Pay Back and suggest them as to which project is best to choose.
YEAR PROJECT A PROJECT B PROJECT C
CASH FLOW (Rs.) CASH FLOW (Rs.) CASH FLOW (RS.)
1 90,000 1,30,000 1,66,667
2 90,000 1,30,000 1,66,667
3 90,000 1,30,000 76,667
4 90.000 80,000 80,000
5 2,30,000 60,000 90,000
Problem 4 (Non discounted Pay back period)
Zenith engineering corporation are thinking of investing in a project costing Rs.20,00000.
You are to calculate Pay Back Period.

YEAR CASH FLOWS (Rs.)

1 4,00000
2 5,00000
3 6,00000
4 6,00000
5 7,00000
 DISCOUNTED PAY BACK PERIOD CALCULATION
In this method of calculation we consider Time Value of Money (TMV). The calculation is
Done after considering TMV and discounting the future cash flows.
Problem 1 (Discounted Pay back period)
A project with an investment of Rs.1000 and has the cash flows as follows. If cost of
capital is 10%, calculate Pay back period.
Solution is in red colour
YEAR CASH FLOWS DISCOUNTING PRESENT CUMULATIVE
Factor AT 10% VALUE OF DISCOUNTED
CASH INFLOWS CASH INFLOWS
1
1 500 0.909 454.5 454.5
(1 + r)n
2 400 0.826 330.4 784.9
Where r=rate of discount
3 300 0.751 225.3 1010.20
n=number of years
4 100 0.683 68.3 1078.2

Years before 2 years + 215.10 = 2+0.954 years = 2.954 years

uncovered cost
full recovery + 225.3
Next year cash flow
Problem 2 (Discounted Pay back period)
Project M with an initial investment of Rs. 50 has the following cash flows. Calculate
pay back if the discounting Rate is 12%
Year Cash flows
1 11
2 19
3 32
4 37

Problem 3 (Discounted Pay back period)

The investment of a project is Rs. 200000 and the cash flows are as follows. Calculate
payback if the discount rate is 10%
Year Cash flows
1 1,66,667
2 1,66,667
3 76,667
Problem 4 (discounted Pay back period)
The expected cash flows of an Engineering project are as follows: The cost of capital is 12%. Calculate Pay back period
YEAR CASH FLOW (Rs.)
0 -1,00000
1 20,000
2 30,000
3 40,000
4 50,000
5 30,000
Problem 5 (discounted Pay back period)

The cash flows for Project A and Project B is given as hereunder. If the cost of capital is
10% calculate Pay back period. Which project you choose?

YEAR CASH FLOWS (Rs.) CASH FLOWS (Rs.)

PROJECT – A PROJECT – B
0 -1000 -1000
1 500 100
2 400 300
3 300 400
4 100 600
 DEPRECIATION
Depreciation is a measure of the wearing out, consumption or other loss of
value of a depreciable asset arising from use, obsolescence through technology
and market changes.
Straight line method of calculating depreciation.

Original cost – estimated scrap value

Formula is Depreciation =
Estimated useful life in years

Problem 1 on Depreciation using Straight Line Method

Cost of machine is Rs. 7800000 and estimated useful life is 5 years at the end of life
the salvage value is expected of Rs. 390000. calculate depreciation using straight
line method.
Solution : original cost Rs. 7800000 Rs. 7800000 – Rs. 390000
estimated scrap value Rs.390000 5 Years
estimated useful life 5 years = Rs. 14,82,000 per annum
Problem 2 on Depreciation using Straight Line Method
A machine cost is Rs. 1000000 and expected life of machine is 6 years at the end of life the salvage value is
Expected of Rs. 100000. calculate depreciation using straight line method.

Problem 3 on Depreciation (if salvage value is not given in the problem)

A co. considering to purchase a machine costing Rs.250000. The machine has a life of 5 years. Calculate
Depreciation using straight line method.
Solution
Original investment Rs. 250000
Depreciation = = = Rs. 50000 per annum
Estimated life 5 years

Problem 4 on Depreciation using Straight Line Method

Suresh & co. is considering to purchase a machine to manufacture chocolates which is costing Rs.
500000. The Machine has a life of 5 years. Calculate depreciation using straight line method.
 NET PRESENT VALUE (NPV)

NPV refers to ‘net benefit’ from the project in today’s value. This is the most
effective and popular technique for making capital budget decisions.

It can be computed thus NPV=Present value of cash inflows – Present value

of cash outflows.

Given an independent proposal/project accept if NPV is positive.

Given exclusive alternatives invest in the alternative with highest NPV

 NET PRESENT VALUE (NPV)
NPV is a classic economic method of evaluating the investment proposals.
Problem 1 on Net Present Value
The initial outlay/investment is Rs. 200000 and the cash flows are as follows. If the
discounted rate is 10%, calculate NPV
Solution in Red Colour
First step – calculate discount factor for each year.
YEAR CASH DISCOUNTING PRESENT Second step – Multiply cash inflow with discounting factor
INFLOW FACTOR @ VALUE Third step – Total all present value of cash inflow
10% OF CASH
INFLOW
Formula is NPV=Cash inflow – Cash outflow(investment)
1 130000 0.909 = 118170 377820 – 200000 = 177820
1/(1+0.1)^1 If the answer is positive then such projects can be
2 130000 0.826 = 107380 accepted.
1/(1+0.1)^2 If the answer is negative then such projects cannot be
3 130000 0.751= 97630 accepted.
1/(1+0.1)^3
4 80000 0.683= 54640
In this problem the answer is 177820 which is a positive
1/(1+0.1)^4 Number. It can be accepted.
TOTAL 377820
Problem 2 on Net Present Value
Project X cost Rs. 2500 and cash flows are as follows. If the discounted rate is 10%,
calculate NPV.
YEAR CASH INFLOW
1 900
2 800
3 700
4 600
5 500

Problem 3 on Net Present Value

A project costs Rs. 16000 and expected cash inflows are as follows: Calculate NPV @ 20%
YEAR CASH INFLOW
1 8000
2 7000
3 6000
Problem 4 on Net Present Value and Discounted Pay Back Period
Calculate Discounted Pay back period and Net Present Value for the
Following two Projects. The firm anticipates its cost of capital to be 10%. Suggest which
Project is profitable

Year Project A cash inflows Project B cash inflows

0 (2,00,000) (2,00,000)
1 35,000 2,18,000
2 80,000 10,000
3 55,000 10,000
4 75,000 4,000
5 20,000 3,000
 Problem 5 on Net Present Value
Calculate NPV at a discount factor of 7% for the following cash flows with an investment of
YEAR CASH INFLOWS Rs. 2,00,000.
1 20,000
2 60,000
3 40,000
4 30,000
5 20,000

Problem 6 on Net Present Value

Calculate NPV at a discount factor of 10% for the following cash flows with investment of
YEAR CASH INFLOWS Rs. 2,00,000.
1 90,000
2 90,000
3 90,000
4 90,000
5 2,30,000
Problem 7 on Net Present Value
Calculate Net Present Value (NPV) for the following two business proposals. Suggest which business proposal
Is acceptable? Why? (Proposal A investment Rs.9,500, Proposal B investment Rs.20,000)
Discounting Factor @ 12%

YEAR PROPOSAL “A” PROPOSAL “B”

CASH INFLOWS (Rs.) CASH INFLOWS (Rs.)
1 4,000 8,000
2 4,000 8,000
3 4,500 12,000
 INTERNAL RATE OF RETURN (IRR)
The IRR method is another discounted cash flow technique which takes account of the
magnitude and timing of cash flows.

IRR is the rate that equates the investment outlay with the present value of cash flow. This
implies that the rate of return is the discount rate at which makes NPV=0.

The IRR is also known as Break even discount rate. In other words, the present value of cash
inflows equals the present value of cash outflows.

Importance of IRR
We know that as borrowing cost raises the NPV declines. Hence, IRR is the limit of cost of
capital for a project.

If borrowing cost exceeds IRR, the NPV turns negative and the project would be rejected.
IRR is related NPV in the sense that a project with a positive NPV will have cost of capital less
than IRR.
 Problem 1
Calculate IRR @ 40% and 50% on the basis of following information. The investment is Rs. 50000. Show
the exact IRR with proof.
Year Cash flow Present Present Present Present
Value factor Vlaue @ Value factor Value @
@40% 40% @ 50% 50%
1 25000 0.714 17850 0.666 16650
2 30000 0.510 15300 0.444 13320
3 35000 0.364 12740 0.296 10360
4 25000 0.260 6500 0.197 4925
5 20000 0.185 3700 0.131 2620
TOTAL 56090 47875
It can be observed that Total PV @ 40% is 56090 which is more than cash outflow(investment) i.e. Rs. 50000.
Hence we can understand that IRR lie between 40% and 50%. Now let us increase PVF to 50% and verify.
When we increase to 50% PV is 47875 which is less than cash outflow (investment) i.e. Rs. 50000.

Hence let us calculate, using the formula

 Original PV – Investment
LDR + X (HDR – LDR)
Original PV – New PV LDR = Lower Discount Rate
HDR = Higher Discount Rate
56090 – 50000
40 + X (50 – 40)
56090 - 47875

6090
40 + X 10
8215

40 + 0.741 X 10

= 47.41% is the IRR

Problem 2
Calculate IRR between 40% and 42% on the basis of the following information. The investment is Rs. 50000.
Show the exact IRR.
Year Cash inflows
1 15000
2 25000
3 30000
4 40000
5 30000

Problem 3
Calculate IRR between 40% and 50% on the basis of following information. The investment is Rs.200000
Year Cash inflows
1 90000
2 90000
3 90000
4 90000
5 230000
 Calculate the exact IRR between 10% and 15% for the following project -S

YEAR CASH FLOWS

(Rs.)
0 -1000
1 500
2 400
3 300
4 100
1449/5600
Problems for practice 1
1. The cash flows of the two projects of Galantac company is given below. The company is
faced with the situation of choosing between the two. Find out the Net Present Value
(NPV) of these projects at 8% discount Rate and indicate which project is preferred.
Also calculate Internal Rate of Return (IRR) for project Boeing(discount range from 13%
to 15%.)
YEAR PROJECT PROJECT
‘AIRBUS’ ‘BOEING’
0 -240000 -240000
1 120000 70000
2 100000 70000
3 70000 70000
4 20000 70000
5 10000 70000
 Based on the following data calculate IRR at 9% and 10% and show the exact IRR for a
YEAR CASH INFLOWS (RS.)
investment of Rs. 1,38,500
1 30,000
2 40,000
3 60,000
4 30,000
5 20,000
995/491

A small engineering enterprise with an investment of Rs.3,10,500 provides the following data. Based on the
data calculate IRR at 13% and 15% and find out the exact IRR.
YEAR CASH INFLOWS (RS.)
1 70,000
2 1,00,000
3 1,30,000
4 90,000
5 60,000
1401 /494
Problem for practice 2
Ajith Singh wants to invest in two projects Air India and Indigo, each of which requires
an outlay of Rs. 50 million. The expected cash inflow from these projects are as follows.
Year Project Project
AIR INDIGO
INDIA
1 20 15
2 10 20
3 15 25
4 30 30

1. What is the pay back period for Air India and IndiGo?
2. If the two projects are independent and cost of capital 12% which project the firm should invest in ? (Hint NPV)
3. Find the IRR for project IndiGo and Air India
Problem for practice 3
ABC engineering company wants to invest in one machine. There are two machines
available namely A and B, each costing Rs. 50000. following table shows cash flows of
two machines.
YEAR MACHINE A MACHINE B
Cash Flows Cash Flows
1 15000 5000
2 20000 15000
3 25000 20000
4 15000 30000
5 10000 20000

1. What is the non discounted Pay Back Period for Machine A and B?
2. What is the discounted Pay Back Period at 10% for machine A and B?
3. If the two machines are independent and cost of capital is 10% which machine should the firm
invest in? Calculate NPV
Problem for practice 4
Consider that an investor has an opportunity of receiving Rs. 1000, 1500, 800, 1100 and Rs. 400 respectively
At the end of one through five years. Find the Present Value of this stream of uneven cash flows, if the
Interest rate is 8%.

Problem for practice 5

Calculate Future Value of the following uneven cash flows if it is invested @ 8% interest per annum.

YEAR AMOUNT
DEPOSITED
1 500
2 1000
3 1500
4 2000
5 2500
Problem for practice 6
Calculate the Future Value at the end of five years of the following series of payments at 10% rate of
interest.
Year Amount
deposited
1 2000
2 2500
3 3000
4 3500
5 4000

Problem for practice 7

Find out the present value of Rs. 3000 received at the end of the year, if the discount rate is 9% p.a.

Problem for practice 8

Calculate the present value of Rs. 50000 received after 2 years, if the discount rate is 8% p.a.
 Problems for Practice on Time Value of Money
1. complete the following, solving for the Present Value (PV)
CASE FUTURE VALUE INTEREST RATE NUMBER OF ANSWER
PERIODS (PRESENT
VALUE)
A Rs.10,000 5% 5 years ?
B Rs.5,63,000 4% 20 years ?
C Rs.5,000 5.5% 3 years ?

2. What is the balance in an account at the end of 10 years if Rs.2,500 is deposited today
and the account earns 4% interest, compounded annually? Quarterly?

Answers i) 10 years annualy = Rs.3,700.61

ii) 10 years quarterly = Rs.3,722.16
3. If you deposit Rs.10 in an account that pays 5% interest, compounded annually, how much
will you have at the end of 10 years? 50 years? 100 years?
answers : for 10 years=Rs.16.29
for 50 years=Rs.114.67
for 100 years=Rs.1,315.01

4. How much will be in an account at the end of 5 years the amount deposited today
is Rs.10,000 and interest 8% per year, compounded semi-annually?
answer : Rs.14,802.44

5. How much interest on interest is earned in an account by the end of 5 years if Rs.1,00,000
is deposited and interest is 4% per year, compounded continuously?
Note: interest on interest is the difference between the FV calculated using compounded interest and the FV calculated using simple interest,
because simple interest included only interest on the principle amount, not the interest-on-interest.
answer: continuously compounded Rs.1,22,140.28
Simple interest Rs.1,20,000
Interest on interest Rs.14,802.44
6. How much I have to deposit in an account today that pays 12%, compounded
quarterly, so that I have a balance of Rs.20,000 in the account at the end of 10 years?
Answer: PV Rs.6,131.14

7. Suppose I want to be able to withdraw Rs.5,000 at the end of 5 years and withdraw
Rs.6,000 at the end of six years, leaving a zero balance in the account after
the last withdrawal. If I can earn 5% on my balances, how much must I deposit today
to satisfy my withdrawal needs?
Given: hint—there are two different future values. Treat as two separate present values,
then combine.
FV=Rs.5,000; n=5, i=5%
PV=Rs.3,917.63

FV=Rs.6,000; n=6, i=5%

PV=Rs.4,477.29
PV of the two Future Values=Rs.3,917.63+Rs.4,477.29=Rs.8,394.92