TIME VALUE OF MONEY

FINANCIAL MANAGEMENT
Why money has time value?
1.Inflation
2.Earning Power of Money
3.Uncertainty
Future Value of Single Amount
( FV )=PV × ( 1+r )n
FV= Future Value
PV = Present Value
r= Interest rate/return
n= number of periods/years

Example: If you deposit Rs. 1000 in a bank at a

rate of 10% p.a. for 10 years, what will you get
after 10 years?
ANS ( FV )=PV × ( 1+ r ) n

( FV )=1000 × ( 1+0.10 )10=Rs .2593 .7

Present Value of Single Amount

( PV )=FV ÷ ( 1+r )n

Example: You are going to receive Rs. 2000000

after 30 years. What is the present value today if
the rate of interest in the market is 10%
ANS
FV= Future Value=2000000
PV = Present Value=?
r= Interest rate/return= 10%
n= number of periods=30 years
( PV )=FV ÷ ( 1+r )n
( PV )=2000000 ÷ (1+.1 )30

=Rs. 114617

Example: You are given two options; Rs. 100 today

or Rs. 150 after 4 years. If the rate of interest in
bank is 9%, which option will you select?
ANS: PV of second option=150/(1.09)^4= 106.3
which is higher than first option(Rs.100) therefore
option-2 is better

Future Value of Annuity

 (1+r )n−1
( FVA )=A { r }
Example: What will you get after 7 years if you
deposit Rs. 10000 every year at a rate of 10% p.a..
ANS:
FVA=Future Value of Annuity
A= Annuity=10000
R=rate of interest/return=.10
N=no. of periods=7
( 1+.1 )7−1
( FVA )=10000
0.1 { =Rs .94871 }
Example: You will need Rs. 1000000 after 5 years.
What amount you must deposit in a bank account
for next 5 years in order to get Rs. 1000000 after 5
years? The bank offers 10% interest.
ANS:
FVA=Future Value of Annuity (Given)= Rs. 1000000
A= Annuity(Missing)=?
R=rate of interest/return=10%=0.10
N=no. of periods=5
( 1+r )n −1
( FVA )= A { r }
(1+0.10)5−1
1000000= A { 0.10 }
A=Rs . 163797 evey year

Present Value of Annuity

 ( 1+r )n −1
( PVA )= A
{ r × (1+ r )n }
Example:
What loan amount you can avail today if you are
able to pay an instalment of Rs. 300000 p.a. for
next 4 years. Assume that the rate of interest is
10% p.a.
ANS
Annuity=Maximum instalment you can pay=300000 p.a.=A
How many years = 4 yrs=n
Rate of interest =10%=r
Present Value of Annuity= What loan amount can you get?
=PVA

( 1+.1 )4 −1
( PVA )=300000
{ .1 × ( 1+.1 )4 }
Rule of 72
It talks about doubling period. Money gets double in 72/r
years(where r is the rate of interest)
Assume that the rate of interest is 10% therefore money will
get double in 72/10=7.2 yrs

n
1+ g
Present Value of Growing Annuity=A 1× { 1− ( )
1+r
r −g
}
Where A 1= A 0 × (1+ g )

Example: (Recall the example of car accident,

discussed in the class)
ANS
Current salary=A0=Rs.1000000 p.a.
G= growth Rate =10%=0.1
A1=Annuity next year= 1100000
R=Discount Rate= 12%=0.12
N=Time period=remaining earning life=30 years
What is the value of the person’s life time
earnings
1+0.1 30
1000000 X (1.10) { (
1−
1+.12
0.12−0.11
}
) =8.70 CR

Example:- (Recall the Mining Example)

Current Production=1000 units
Current Price= Rs. 100
A0=100000 A1=100000 X (1.06)=110000
Number of years = 10
Growth in price = 6% p.a.
r=10%
What price can be paid for the mining rights?
1+ 0.06 10
100000 X (1.06) { 1− (
1+.10
0.10−0.06
}
) =Rs. 820309

Present Value of Perpetuity

PV= P/r
10000=1000/0.10

Present Value of Growing Perpetuity

PV= P1/(r-g) = P0 X(1+g)/(r-g)

10000=1000/0.10

Annuity Due
Effective Vs. Stated rate
Real Vs. Nominal Rate
Practice Problems
1.You can save Rs. 3000 a year for 5 years and
Rs. 8000 a year for 10 years thereafter. What
will these savings cumulate to at the end of 15
years, if the interest rate is 10% p.a.?
=3000 X FVA Eq. X (1+r)^10 + 8000 X FVA Eq.

2. Mr. Mehta plans to send his son for higher

education after 8 years. He expects the cost
of these studies to be Rs. 2000000. How much
should he save annually to meet the
requirement? Assume rate of 8% p.a.
ANS: 188029

3.At the time of retirement, Mr. Shah is given

two options; (i) An annual payment of
Rs.200000 as long as he lives,
(ii) A lumpsum amount Rs. 2000000 today. If
Mr. Shah expects to live for 15 years and the
interest rate is 8%, which option should he
choose?
 ANS: Compute the present value of annuity of
Option-1 and compare it with the second
one(1711895).
1711895 < 2000000, option-2 is better

4.Ms. Janki deposits Rs. 5000000 in a bank that

pays 10% interest. How much can she
withdraw annually for a period of 20 years.
Assume that after 20 years the account
balance will become zero
ANS: 587298

5.What is the present value of an income

stream that provides Rs. 100000 at the end of
each of year 1 through year-3, Rs. 300000 at
the end of each of year 4 through year-6 and
Rs. 500000 every year, forever thereafter?
The interest rate is 10%.
Year Cash Flow Present Value
1 100000 90909
2 100000 82645
3 100000 75131
4 300000 204904
5 300000 186276
6 300000 169342 PV Today
7 onwards 500000 5000000 2822369.65
PV after 6 years
Total PV 3631577
6. What amount must be deposited today in
order to earn an annual income of Rs. 200000
starting from the end of 12 years from now
and continuing for 10 years thereafter? The
deposit earns 10 percent per year.
ANS=1228913/(1.10)^11=430726

7.If the interest rate is 10 percent how much

investment is required now to yield an income
of Rs.100000 per year from the beginning of
the 10th year and continuing thereafter
forever?

8. How much should be deposited at the

beginning of each year for 5 years in order to
provide a sum of Rs. 200000 at the end of 5
years ?

9.A person requires Rs. 90000 at the end of

each year from 2031 to 2037. How much
should he deposit at the end of each year
from 2021 to 2026? The interest rate is 12
percent.
10. A person requires Rs. 90000 at the
beginning of each year from 2031 to 2037.
How much should he deposit at the end of
each year from 2021 to 2026? The interest
rate is 12 percent.