Beruflich Dokumente
Kultur Dokumente
1. Introduction
Companies take up new projects, where they invest money
for the benefits expected over a period of time in future.
4 Cr
1 Cr
Investment
1 Cr
1 Cr
1 Cr
1 Cr
1. Introduction
Concept of Time Value of Money
One rupee at present is worth more than one rupee next
year. Because one rupee at present can be invested to
earn an income. Value of money at present is more than
value of money in future time. Hence we can say money
has a value based on time. This concept is called as time
value of money or an interest.
4 Cr
1 Cr
Investment
Present values
0.47Cr
total 3.26 Cr
1 Cr
0.86Cr
1 Cr
0.74Cr
1 Cr
0.64Cr
1 Cr
0.55Cr
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1. Introduction
How to determine the time value of money and use it into
cash flows of a project?
We are going to study these things in this chapter.
Nominal or market interest rate depends on real interest
rate, inflation and uncertainty about future.
Nominal or market interest rate = Real interest rate +
expected inflation rate + risk premium for uncertainty
Due to inflation, a rupee today has higher purchasing
power than rupee in future.
Future is characterized by uncertainty, which require some
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Compounding
0
-1000
2
250
500
3
750
4
750
+
FV(750)
+
FV(500)
+
FV(250)
compare with
FV(1000)
Discounting
0
1
-1000
2
250
3
500
4
750
750
compare with the
sums of PV(250)
+
PV(500)
+
PV(750)
+
PV(750)
FVn PV (1 k)
FVn = PV x FVIF(k,n)
= PV x FVIF(11,3)
= 10,000 x 1.368
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0.35
69
Interest Rate
= 0.35 + 69/10
= 0.35 + 6.9
= 7.25 years
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FVn
(1 k) n
PV
log(FV n/PV)
log(1 k)
log 2
7.27
log 1.1
years
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Profits in lakh
95
105
140
160
165
170
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Profits in lakh
95
105
140
160
165
170
Solution:
Ratio of profits for last year to first year = 170 / 95 = 1.79
Refer FVIF(k,n-1) table (Table 1)
Look for the value close to 1.79 for 5 years
The value close to 1.79 is 1.762 and corresponding interest
rate is 12 %.
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170 = 95 (1+k)5
1+k = (170/95)1/5
=
1.79
= 1.1235
k = 0.1235 or 12.35%
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k m
) 1
m
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= 1.034 -1
k m
) 1
m
0.12 4
) 1
4
= 1.126 -1
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1
2000
2
3000
3
Accumulation
FV(3000)
+
FV(2000)
+
FV(1000)
1
2000
2
3000
3
Accumulation
FV(3000)
+
FV(2000)
+
FV(1000)
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Which reduces to
(1 k) n 1
FVA n A
The expression
is called the Future Value
k
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(1 k) n 1
FVA n A
FVAn = A x FVIFA(k,n)
= 1000 x FVIF(12,10)
= 1000 x 17.549
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(1 k) n 1
FVA n A
(1 0.12)10 1
FVA n 1000
0.12
= 1000 x 17.54874
= Rs. 17548.74
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0.09 4
) 1 0.0931 or 9.31%
4
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(1
r)
1
Rate of interest per month
(1 0.0931)1/12 1
0.0074 or 0.74%
(1 k) n 1
FVA n A
(1 0.0074) 12 1
500
0.0074
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240.1 207.33
244.71 207.33
= 14 + 1 x 32.77 /37.38
= 14 + 0.87 %
= 14.87 %
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PV
FVIF(k, n)or
FVn
PV
(1 k) n
= FV x PVIF(k,n)
= 1000 x PVIF(12,5)
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1000
(1 0.12)5
Rs. 567.43
38 / 57
k m
r (1 ) 1
m
0.12 4
(1
) 1 0.1255 or 12.55%
4
FVn
PV
(1 k) n
100
Rs. 88.85
(1 0.1255)
39 / 57
0.10 4
) 1 0.1038 or 10.38%
4
FVn
(1 k) n
100000
Rs. 37247.41
10
(1 0.1038)
40 / 57
PV
6. Present Value of
Multiple Flows and Annuity
0
1
Accumulation 1000
2
2000
3
3000
PV(1000)
+
PV(2000)
+
PV(3000)
6. Present Value of
Multiple Flows and Annuity
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A
A
A
A
...
(1 k) (1 k) 2 (1 k) 3
(1 k) n
This reduces to
(1 k) n 1
PVA n A
n
k(1
k)
(1 k) n 1
n
is
called
k(1
k)
The expression
the PVIFA, Present Value
Interest Factor for Annuity and it represents the present
value of a regular annuity of Rs. 1 for a given value of k
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(1 k) n 1
PVA n A
n
k(1
k)
(1 0.12)10 1
10,000
10
0.12(1
0
.
12
)
2.10585
10,000
Rs. 5650.23
0.3727
45 / 57
0.12 4
(1
) 1 0.1255 or 12.55%
4
k)
0.0099(1
0.0099)
0.1255
1000 x 11.26336 Rs. 11,263.36
0.01114
46 / 57
1000
0.11 4
) 1 0.1146 or 11.46%
4
(1 0.00908) 60 1
4610 A
60 99.8833
A
=
Rs.
0.00908(1
0.00908)
47 / 57
n
k(1
k)
(1 k) n 1
A PVA n
n
k(1
k)
k(1 k) n
PVA n
n
(1
k)
The term
k(1 k) n
n is known
(1
k)
1
k)
k(1 k) n
A PVA n
n
(1
k)
0.11(1 0.11) 5
10,000
Rs. 29,129
5
(1 0.11) 1
1
A(1+g)
2
A(1+g)2
3
A(1+g)3
n
A(1+g)n
(1 g) n
1(1 k) n
k -g
(1 g)
harvest.
1 - (1 k) n
A(1 g)
Solution: PV of Growing Annuity
k -g
(1 0.08) 20
1(1 0.15) 20
Rs.55,17,3 6,683
0.15 - 0.08
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8. Present Value of
Perpetuity and Growing Perpetuity
An annuity of an infinite duration is known as perpetuity.
The present value of such perpetuity is expressed as
P = A x PVIFA(k,)
Where PVIFA(k,) is a present value interest
factor
for a
1
1
perpetuity. Value of PVIFA(k,) is
t 1
(1 k)
A
r
8. Present Value of
Perpetuity and Growing Perpetuity
Example: How much I should invest in a bank to offer a
scholarship of Rs. 10,000 per annum perpetually
(forever) to a bright student with 10% p.a.
Solution
A
r
10,000
Rs.1,00,00 0
0.10
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8. Present Value of
Perpetuity and Growing Perpetuity
Example: How much I should invest in a bank to offer a
scholarship of Rs. 1000 per month perpetually (forever)
to a bright student with 10% p.a.
Solution:
Effective rate of interest per month = (1.10)1/12-1
= 0.007974 or 0.7974%
A
r
1000
Rs.1,25,40 8
0.007974
55 / 57
A(1+g)
A(1+g)2
A(1+g)3
(1 k)
This reduces to
PV of growing Perpetuity
(1 k)
(1 k)
...
(1 k)
...
A
k -g
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A
k -g
30,000
Rs. 6,00,000
0.10 - 0.05
Perpetuity
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