Time Value of Money

Ram Chandran is trying to sell a

piece of land in Ghaziabad.
Yesterday, he was offered Rs.
12,00,000 for the property. He was
about ready to accept the offer
when another individual offered
him Rs. 13,26,000. However, the
second offer was to be paid a year
from now. Ram has satisfied
himself that both buyers are
honest and financially solvent, so
he has no fear that the offer he
selects will fall through.

Future Value of Single Amount

Future value is the value at a given
future date of present amount placed
on deposit today and earning interest
at a specified rate. It depends on the
rate of interest and the length of time.
Concept of Compounding.
FVn = PV (1+i)n
Jane placed Rs.40,000 in a fixed
deposit account getting 8% interest
compounded annually. She wants to
know how much money she will get at
the end of 6 years.

 Doubling Period
Future Value of Multiple Flow.
Suppose we invest Rs.1000 now
(beginning of year 1, Rs.2000 at the
beginning of year 2 and Rs.3000 at the
beginning of year 3. How much these
cash flow accumulate at the end of year
3. If the interest rate is 12% p.a.

Nominal Rate Vs. Effective Rate of Interest

Compound Interest with non-annual Period:

FV = PV (1+i/m)nm
r = (1+i/m)m 1 [m = frequency of
compounding].
Find out the effective rate of interest if the
nominal rate of interest is 12% and
compounded quarterly.
Continuous Compounding.
e.g. Calculate the compounded value of
Rs.1000, interest rate being 12% p.a. and
compounded continuously for 2 years.

 Under Pragati Cash Certificate Scheme

of Syndicate Bank, a small odd sum can
be invested for a period of 10 years. The
certificates are issued in convenient
denomination of Rs.1000, Rs.10,000 and
Rs.1,00,000. The rate of interest is 12%
p.a. compounded quarterly.
What is the issue price of a certificate of
Rs.1,00,000?

Annuity
An annuity is a stream of equal periodic
cash flows, over a specific time period.
Mr. Vijay have started saving Rs.
60,000 every year in a bank deposit @
8% for next 5 years for his son, when
he would be ready for admission in an
engineering college.
FVA =A

Sinking Fund: An Application

It is a fund which is created out of fixed
payments in each period to
accumulate a future sum after a
specific period.
Mr. Rajiv plans to send his son for
studying MBA after 10 years. He
expects the cost of study would be 15
lakhs. How much should he saved
annually if he gets an interest rate of
10%.

Ordinary Annuity Vs. Annuity Due

In
general, we assume that the series of cash

flows occur at the end of the period. This is

an example of ordinary annuity.
In practice, (e.g. lease, hire purchase) usually
the cash flows take place in the beginning of
the period, subsequent installments also in
the beginning of the period.
Annuity due is a series of fixed
receipts/payments starting at the beginning
of each period for a specific number of
period.
FVAD=A(1+i)

Present Value of Single

Amount

Present value is the current Rupee value of a

future amount.
The amount of money that would have to be
invested today at a given interest rate over
a specific period to equal the future amount.
Concept of Discount.
PV = FV/ (1+i)n
Mr. Sam wish to find the present value of
Rs.1,70,000 to be received 8 years from
now, assuming an 8% opportunity cost.
Similarly, we can calculate present value of
annuity.

Present Value of Multiple Flow

Yea Option Option Option
r
1
2
3
1

100

500

1000

200

500

900

300

500

800

400

500

700

500

500

600

600

500

500

700

500

400

800

500

300

900

500

200

10

1000

500

100

5500

5000

5500

PV
3625

2591

2825

If the discount rate is

12% compare the
different alternatives.

Capital Recovery

Capital Recovery is the annuity of an

investment for a specific time at a
given rate of interest.
The reciprocal of the present value
annuity factor is called the capital
recovery factor.
Suppose you have taken a bank loan of
Rs.3,00,000 for 5 years to buy a car.
You have to pay interest of 12% p.a.
What would be the annual installment
you need to pay.

Loan Amortization

Loan to buy a flat = Rs. 22 lakh

Floating rate = 9% - 11%
Repayment period = 20 years
Payment interval = Monthly

Construct a loan amortization schedule.

Present Value of Perpetuity.

Perpetuity is an annuity that occurs
indefinitely.
An investors expects a perpetual sum
of Rs.500 annually for his investment.
What is the present value of the
perpetuity if the rate of interest is 10%.