TIME VALUE OF MONEY

Learning Outcomes
• Students will be able to:

• Understand the concept of time value of

money.
• Calculate the future value of lump sum
deposited/ invested today.
News
• https://economictimes.indiatimes.com/sma
ll-biz/startups/newsbuzz/experts-at-a-loss-
to-explain-taxmens-flipkart-
math/articleshow/62641097.cms

• https://economictimes.indiatimes.com/new
s/politics-and-nation/priyanka-chopra-is-
liable-to-pay-tax-on-toyota-car-says-
itat/articleshow/62643075.cms
 Case analysis - I
• James was a brilliant student. His overall
CGPA score in two year program of masters
was 9.5.
• The university decided to provide him a
scholarship $1000.
• Close to the date, he was about to receive his
scholarship, the university gave him the
following two options:
– He can receive $1000 right now in current year
or
– He can receive the same in next year
• James used his intelligence and decides
to receive the scholarship amount
immediately in current year.
• “What made you to arrive at this
decision?”, his friend, Jack enquired.
• James gave his friend the following
justification for his decision to go for option
I.

• If I deposit 1000$ today in a bank, @10%

rate of interest, year after it would turn out
to be 1100$.
• If I receive the same amount in 2018, I will
loose 100$.
 Concept
• Also known as time preference for money
• Money in hand today is worth more than
money received at future date

• “A bird in hand is equal to two in the bush”

 Reasons why money today has
more value than in future
• Future uncertainty
• Preference for present consumption
• Reinvestment opportunities
 Case Analysis - II
• Bajaj Autos, two wheeler manufacturing
company purchases a machine for
production of spark plugs for Rs. 100,000.
• This machine is expected to give a return
of Rs. 125,000 after one year.
• The company is incurring the cost of Rs.
100,000 today & will receive Rs. 125,000
after one year.
• The cash outflow and cash inflow are
occurring at different period of time and
hence not comparable.

• How it can be made comparable?

Compounding Technique

Discounting Technique
 Future value FV of single
present cash
Compounding flow
technique
FV of series of
cash flows
• Simple interest
– Interest charged on initial principal amount

• Compound interest
– Interest charged on initial principal + every
previously calculated interest
 In case of simple interest
Year Outstanding Interest @ 10% Outstanding
amount at amount at end
beginning

1st $1000 $100 $1100

2nd $1100 $100 $1200

3rd $1200 $100 $1300

In case of compound interest
Year Outstanding Interest @ 10% Outstanding
amount at amount at end
beginning

1st $1000 $100 $1100

2nd $1100 $110 $1210

3rd $1210 $121 $1331

• In case of simple interest
FVN = PV (1 + i*n)

• In case of compound interest

FVN = PV (1 + i)n
 Problem solving
• El is having $1000 as cash – in – hand. He
decides to deposit the same in his savings
bank account which will fetch him interest
@5% for three years.
• You are required to calculate the FV
using:-
– Simple interest
– Compound interest
 Problem Solving
• Ed deposited Rs. 55650 in a bank which
was paying 15% rate of interest on 10 year
deposit
• Calculate how much would deposit grow at
end of 10 years?

• Tables.xls
 Problem solving
• Zed Bank pays 12% and compounds
interest quarterly. If Rs. 1000 is deposited
initially, how much it will grow at the end of
5 years?

• Tables.xls
 Problem solving
• Rs. 2000 is invested at annual interest rate
of 10%. What is the amount after 2 years if
compounding is done?
• Annually?
• Semi – annually?
• Monthly?
 Problem solving
• Mr. X decides to invest Rs. 10,000 in a 3
year term, each year deposit at 8%
compounded annually.
a)What will be the future value of investment
of Rs. 10000?
b) Will your answer be different if the interest
is compounded half – yearly?
Give reasons for the support of your answer
• Ascertain the Future value of and
compound interest of an amount of Rs.
75000 at 8% compounded semi – annually
for 5 years.
 Annuity
• Fixed payments or receipts each year for
specific number of years.

• For example:-
– Ed had taken land on rental basis to carry out
production activities. He promises to pay
series of rental payments every year for next
7 years.
– Rental payments = annuity
Compound value of annuity
 Problem solving
• A person is required to pay annual
payments of Rs. 8000 in his deposit
account that pays 10% interest
• Find the FV of annuity at end of 5 years
 Problem solving
• A person invests Rs. 5000 at the end of
each year at 10% rate of interest per year.
State what amount he will receive at the
end of 4 years.
 Problem solving
• Determine the future value at the end of 5 years
of the following series of payments at 5% rate of
interest
• At the end of 1st year = Rs. 1000
• At the end of 2nd year = Rs. 2000
• At the end of 3rd year = Rs. 3000
• At the end of 4th year = Rs. 4000
• At the end of 5th year = Rs. 5000
 Present Value
• Amount to be invested today at given rate
over specified period to equal the Future
amount
• Discounting the future amount converts it
into present value amount.
 Formula

P0=FVn*(1/(1+i)n)
 Problem solving
• What is the present value of Re. 1 to be
received after 2 years compounded
annually at 10%?
 Problem solving
• Find the PV of Rs. 10000 to be required
after 5 years if the interest rate is 9%.
 Problem solving
• An investor wants to find out the present
value of Rs. 50000 to be received after 15
years. The interest rate is 15%.
 Problem solving
• Calculate the present value of Rs. 600
(a)Received one year from now
(b)Received at the end of 5 years
(c)Received at the end of 15 years.
Assume a 5% time preference rate.
 Problem solving
• Mr. Rajan is to receive Rs. 5000 after 5
years from now. His time preference for
money is 10% p.a. Calculate is present
value, if the discount factor is 0.621.
 Present Value Of An Annuity
• Formula= P0=A*((1+i)n-1)/i(1+i)n)
 Problem solving
• Determine the present value of Rs. 700
each paid at the end of the next 6 years.
Assume an 8% of interest.
 Problem solving
• At the time of his retirement, Mr. X is given
a choice between two alternatives
1. An annual pension of Rs. 10000 as long
as he lives, and
2. A lump sum payment of Rs. 60000.
If Mr. X expects to live for 15 years and rate
of interest is 15%, which alternative should
he select?
 Problem solving
• How much will a recurring investment of
Rs. 10,000 per annum accumulate to at
the end of 30 years where the investment
fetches an interest rate of 9.5% per annum
if compounding is:
1. Annual
2. Quarterly
3. Monthly
 Problem solving
• You make a fixed deposit of Rs. 100000 in
Canara Bank for 5 years. The annual interest
rate is 12%. How much total amount will you
receive after 5 years if the interest is
compounded:
1. Annually
2. Half-yearly
3. Quarterly
4. Monthly
Present value of uneven cash flows
• An investor has an opportunity of receiving
Rs. 1000, Rs. 1500, Rs. 800, Rs. 1100
and Rs. 400 respectively at the end of
each of the five years.
• You are required to find out the present
value of this stream of uneven cash flows,
if investor’s required rate of interest is 8%.
Future value of uneven cash flows
• Mr. X invested Rs. 500, Rs. 1000, Rs.
1500, Rs. 2000 and Rs. 2500 at beginning
of each year.
• Calculate the compound value at end of
5th year, compounded annually, when
interest is charged at 5%.
 EMI
• Equal money payable at periodic intervals
of time usually a month that is equal to the
amount of loan principal and interest
thereon at a given rate
 Problem Solving
• A loan of Rs. 50000 is to be re – paid in
equal instalments of Rs. 14000.
• The loan carries an interest rate of 6%.
• How many payments are required to repay
this loan?
 Problem solving
• A loan of Rs. 1000 is to be re – paid in
three yearly equal instalments.
• The loan carries an interest rate of 10%.
• Calculate:
– Instalment amount to be paid
– Payments required to repay this loan
 Perpetuity
• An annuity that occurs indefinitely
• PV of perpetuity = A/I
– where, A = Annual Cash Flow
– i = Interest rate
Difference between Annuity and
Perpetuity
• Both are paid annually and regularly but
the main difference is time period.
• Annuity is paid for a specified period of
time, but perpetuity is paid forever.
• Annuity has an end life, perpetuity has no
end.
 Problem solving
• An investor expects a perpetual sum of
Rs. 500 annually from his investment.
• What is the PV of this perpetuity if interest
rate is 10%?
 Problem solving
• A finance company makes an offer to
deposit a sum of Rs. 1100 and then
receive a return of Rs. 80 p.a. perpetually.
Should this offer be accepted if the rate of
interest is 8%?
• Will the decision change if the rate of
interest is 5%?
 Nominal and effective rate of
interest
• Interest rates are typically stated as annual
percentages. The stated annual rate is
usually referred to as the nominal rate.
• Interest may be compounded semiannually,
quarterly, and monthly, the interest earned
during a year is greater than if compounded
annually.
• When compounding is done more frequently
than annually, an effective annual interest
rate can be determined.
 Problem Solving
• A deposit of Rs. 10000 is made in a bank
for a period of one year.
• The bank offers 2 options:
a)To receive interest @12% p.a.
compounded monthly or
b)To receive interest @12.25%
compounded half – yearly
• Which option should be accepted?
 Problem solving
• A student is awarded a scholarship and
two options are placed before him
a)To receive Rs. 1100 now or
b)To receive Rs. 100 p.m. at end of each of
next 12 months
• Which option should be chosen if the rate
of interest is 12%?
 Problem solving
• An investor deposits a sum of Rs. 100,000
in a bank account on which interest is
credited at rate of 10% p.a. How much
amount can be withdrawn annually for
period of 15 years?