Time Value of Money

Present and Future Value

Present Value Value today of a future cash flow. Future Value Amount to which an investment will grow after earning interest

Future Values
Future Value of Rs.100 = FV
FV Rs.100 (1 r )

Future Values
FV Rs.100 (1 r )
Example - FV
t

What is the future value of Rs.400,000 if interest is compounded annually at a rate of 5% for one year?

FV Rs.400,000 (1 .05) Rs.420,000

1

Discount Factors and Rates

Discount Rate Interest rate used to compute present values of future cash flows.

Discount Factor Present value of a Rs.1 future payment.

Present Values
C1 PV DF C1 1 r1
DF
1 (1 r ) t

Discount Factors can be used to compute the present value of any cash flow.

Present Values
Rs.200 Rs.100 Present Value Year 0
0 1 2

Year

100/1.07 200/1.0772 Total

= Rs.93.46 = Rs.172.42 = Rs.265.88

Risk and Present Value

Higher risk projects require a higher rate of return Higher required rates of return cause lower PVs

PV of C1 Rs.420 at 5% 420 PV 400 1 .05

Risk and Present Value

PV of C1 Rs.420 at 12% 420 PV 375 1 .12

PV of C1 Rs.420 at 5% 420 PV 400 1 .05

Present Values
PVs can be added together to evaluate multiple cash flows.

PV

C1 (1 r )
1

(1r )2 ....
C2

Net Present Value

NPV = PV - required investment C1 NPV = -C 0 1 r

Net Present Value

+Rs.320,00 0

-Rs.170,000
Present Value Year 0 -170,000
0

Rs.100,000 Year
1 2

= -Rs.170,000

-100,000/1.05 = Rs.95,238
320,000/1.052 = Rs.290,249 Total = NPV = Rs.25,011