Beruflich Dokumente
Kultur Dokumente
Madumathi
MODULE 2
Finance – An Introduction
responsibilities and in many instances, the finance manager could also done the
decision and its consequences. This also helps the organization to aim at a
price. If you own money, you can, 'rent' it to someone else, say a banker, who
can use it to earn income. This 'rent' is usually in the form of interest. The
investor's return, which reflects the time-value of money, therefore indicates that
there are investment opportunities available in the market. The return indicates
that there is a
consumption
Future value (FV) and present value (PV) adjust all cash flows
to a common time. This is relevant when we want to compare the cash flows
turnover, the cash flows accrue to the company at different stages. The
evaluation of all these cash flows are true when they are all brought to the same
base period.
amount, if invested would certainly bring additional returns in the future. This
future expectation from the present investment is termed as the future value.
PV = Rs. x
FV = Rs. x + (r * x)
PV = Rs.1,000
This relationship leads to the following concept of discounting the future value to
PV = FV / (1 + r)
This is the formula for equating the future value that is associated at the end of
1st year. Now the concept of time over a longer duration can be easily brought
into the above equation, where 'n' defines the time duration after which the cash
Here FV = Rs.1,000
• Interest with annual compounding adds the interest received earlier to the
principle amount and increases the final amount that is received from the
investment. Hence, the FV of an investment for a two year duration with
annual compounding would be:
FV = PV * (1+r)* (1+r) = PV * (1+r)^2.
Compound Value
In compounding, it is assumed that a certain sum accrues at the end of a time
will yield interest and the interest is reinvested for the next year and so on till the
time when withdrawal is made. The 3 year or 4 year bank deposit is a typical
FV = Principal + interest
FV = P(1+r)^n
lump sum of Re.1, and it always has a value greater than 1 for positive r,
FV = Principal + interest
FV = P(1+r)^n
FV = 1000 x (1+.10)^3
= 1000 x 1.331
= Rs.1,331.
When half-yearly interest payments are made 'm' will be 12/6 i.e., 2. When
quarterly interest payments are made 'm' will be 12/3 i.e., 4. When monthly
compounding is done then 'm' will be 12/1 i.e., 12. Compounding on a daily
basis, 'm' will be 365/1 i.e., 365. This is referred to as multi-period compounding.
Continuous Compounding
FV = PV x {e^x}
When x = (r * n) and e is mathematically defined as equal to 2.7183.
Annuity
There can be a uniform cash flow accrual every year over a period of 'n' years.
FV = A {[(1+r)^n - 1]/ r}
The term within the curly brackets {} is the compound value factor
PV = A {[1 - 1/(1+r)^n]/r}
Annuity – Example
The Future value of Rs.10 received every year for a period of 5 years at an
PV =100{[1 - 1/(1+0.1)^5]/0.1}=Rs.379.08
PV = A/r
• When an annuity's cash payments are made at the end of each period, it
is referred as regular annuity. On the other hand, the annual
payments/receipt can also be made at the beginning of each period. This
is referred to as annuity due.
• Lease is a contract in which lease rentals (payment) are to be paid for the
use of an asset. Hire purchase contract involves regular payments
(installments) for acquiring (owning) an asset. A series of fixed payments
starting at the beginning of each period for a specified duration is called an
annuity due.
Annuity Due
FV = A {[(1+r)^(n-1) -1] / r}
Hence,
PV = A {[1 - 1/(1+r)^n]/r } * (1+r)
PV = A(PVRA,r)*(1+r)
Where PVAR is present value of regular annuity and r is the interest rate.
The future value of Rs.10 received in the beginning of each year for a 5 year
duration at an assumed rate of 10% p.a. will be:
In all instances, the discount rate will be (r/m) and the time horizon
will be equal to (n x m).
PV = 100 x {(1/0.08)-[(1/0.08)*(1.02)^5/(1.1)^5]}
= Rs.393.07.
FV = 10 x {[1.1^5/0.08]-[1.02^5/0.08]}
= Rs.63.30
PV = A / (r - g)
In financial decision-making there are number of situations where cash flows may
grow at a compound rate. Here, the annuity is not a constant amount A but is
subject to a growth factor 'g'. When the growth rate 'g' is constant, the formula
can be simplified very easily. The calculation of the present value of a constantly
growing perpetuity is given by the following equation:
PV = A / (r - g)
PV = A / (r - g)