Beruflich Dokumente
Kultur Dokumente
Value of
Money
1
Learning Objectives
2
Chapter Outline
Compounding concept
Discounting concept
Annuities and its types
Loan Amortization schedule
Saving and Retirement Plan
3
Focus on Principles
Time Value of Money
The value of a cash flow depends on when it
will occur.
4
4.2 Valuing Single Cash Flows
In this section, we explain how time affects the
value of a cash flow.
5
Selected Notation
APR Annual Percentage Rate or nominal rat
PV Present Value
FV Future Value
r The discount rate per period
m The number of compounding periods per
year
n A time period
6
The Time Line
End of Start of
second year third year
Today
7
Future Value Formula
Let PV = Present Value
FV= Future Value at time n
r = interest rate (or discount rate) per period.
FV PV (1 r ) n
8
Time value of money
Q#1: A person deposited Rs. 500,000 for one year
in account at 12%. How much he has in account
after one year?
Formula :
PV = Rs. 500,000 FV PV (1 r ) n
9
Time value of money
Q#2: A person deposited Rs. 500,000 for two
years in account at 12%. How much he has in
account after two years?
Formula :
PV = Rs. 500,000 FV PV (1 r ) n
r = 12%
FV 500,000(1 0.12) 2
n = 2 years
FV 500,000(1.2544)
FV= ?
FV 627,200
10
Future Value
Q#3: Suppose you invest Rs.1,000 at an expected
return of 10% per year. How much money do
you expect to have at the end of the 5 years?
11
Present Value Formula
Let PV = Present Value
FV= Future Value at time n
r = interest rate (or discount rate) per period.
1
PV FV n
(1 r )
12
Time value of money
Q#4: A person required Rs. 110,000 after one
year in account while bank offered rate is 10%.
How much he should deposit today?
Formula :
FV = Rs. 110,000
1
n = 1 year PV FV n
(1 r )
r = 10%
1
PV = ? PV 110 ,000 1
(1 0 .1)
PV 110 ,000(0.9091)
PV 100,000
13
Time value of money
Q#5: A person required Rs. 540,000 after three
years in account while bank offered rate is 12%.
How much he should deposit today?
Formula :
FV = Rs. 540,000
1
n = 3 years PV FV (1 r ) n
r = 12%
1
PV = ? PV 540,000 5
(1 0 . 12 )
PV 540,000(0.5674)
PV 306,396
14
Present Value
Q#6: You expect to receive Rs.10,000 six years
from today. If the required return is 9% per
year, what is the money worth today.
Formula :
FV = Rs. 10,000
1
n = 6 years PV FV n
(1 r )
r = 9%
PV = ? 1
PV 10,000 6
(1 0 .09)
PV 5,962.67
15
Calculation of rate
Q#7: A person deposited Rs.100,000 today and
bank promised to pay Rs.126,000 after three
years. What rate offered by bank?
Formula :
PV = Rs. 100,000
FV PV (1 r ) n
FV= Rs. 126,000 1/ n
n = 3 years FV
r 1
PV
r =?
1/ 3
126,000
r 1 8%
100,000
16
Time value of money
Q#8: A person deposited Rs.200,000 today and
bank promised to pay Rs.400,000 after five
years. What rate offered by bank?
r 1 14.87%
200,000
17
Concept of Effective Annual rate
Annual Percentage Rate (APR) = 10%
Compounding Intervals (m) = Half yearly (2)
Deposited Amount = Rs.100
0 6 months 1 year
18
Concept of Effective Annual rate
Annual Percentage Rate (APR) = 10%
Compounding Intervals (m) = Quarterly (4)
Deposited Amount = Rs.100
0 3m 6m 9m 1y
19
Concept of Effective Annual rate
Compounding m
Yearly 1
Half Yearly 2
Quarterly 4
Monthly 12
Daily 365
20
Concept of Effective Annual rate
Consider an APR of 10% with half yearly
compounding. What is the EAR?
m 2
APR 0.10
EAR 1 1 1 1
m 2
21
Concept of Effective Annual rate
Consider an APR of 10% with quarterly
compounding. What is the EAR?
m 4
APR 0.10
EAR 1 1 1 1
m 4
22
Concept of Effective Annual rate
Consider an APR of 10% with monthly
compounding. What is the EAR?
m 12
APR 0.10
EAR 1 1 1 1
m 12
23
Concept of Effective Annual rate
Compounding m APR EAR
24
From EAR to APR
This topic you will cover in Tutorial class
by calculating it yourself.
EAR will always be higher than APR
As compounding intervals within a year
increasing, EAR will be much higher than
APR
25
Question
Bank compounding quarterly, how much we
will have after 3 years after depositing
Rs.1,000 at the rate of 15%?
Data: Using: nm
PV = Rs.1,000 r
FV PV 1
r = 15% m
3*4
n = 3 years 0.15
m = 4 FV 10001
4
FV= ?
FV 1,555.45
26
Valuing Annuities
An annuity is a series of equal periodic
cash flows.
It must have defined time limit
27
Annuity example
A person deposited Rs.5000 per year for 4
years.
Isit Annuity?
YES
Reason
Fixed installment Rs.5000
Time interval is fixed one year
Time limit defined 4 years
28
Annuities
An annuity is a series of identical cash flows that
are expected to occur each period for a
specified number of periods.
Examples of annuities:
Installment loans (car loans, mortgages).
Rent payment on your apartment.
29
Is this Annuity?
Q) What will be the future value of following cash
flows at year 5. Offered rate is 10%.
0 1 2 3 4 5
800 900 850 700 600
No
Because cash flows are different.
30
Is this Annuity?
Q) What will be the future value of following cash
flows at year 5. Offered rate is 10%.
0 1 2 3 4 5
800 800 800
No
Because cash flows are not in series, the cash
flows of year 2 and 5 are missing.
31
Is this Annuity?
Q) What will be the future value of following cash
flows at year 5. Offered rate is 10%.
0 1 2 3 4 …..... N
800 800 800 800 ……….
No
Because no time limit defined.
32
Two Types of Annuities
Ordinary Annuity:
An annuity with end-of-period cash flows, beginning
one period from today.
For example, a car loan
Annuity Due:
An annuity with beginning-of-period cash flows.
For example, an apartment lease
33
Ordinary Annuity
Q) Suppose you save Rs.1,000 per year at the end
of each year for 4 years and earn 10% interest per
year. How much will you have at the end of 4 years?
0 1 2 3 4
End
34
Annuity Due
Q) Suppose you save Rs.1,000 per year at the
beginning of each year for 4 years and earn 10%
interest per year. How much will you have at the end
of 4 years?
0 1 2 3 4
Beginning
1000 1000 1000 1000
35
Future Value of an Ordinary Annuity
FV of Rs.2,000 per year for 5 years, at 10% per year:
Future value calculated by compounding forward one period at a time
Future value calculated by compounding each cash flow separately
0 1 2 3 4 5
Time
(years)
2,000 2,000 2,000 2,000 2,000
x 1.1 2,200.0
x 1.12 2,420.0
x 1.13 2,662.0
x 1.14 2,928.2
36 Total future value Rs.12,210.2
Ordinary Annuity
Future Value:
(1 r ) n 1
FVA n PMT
r
Present Value:
1 (1 r ) n
PVA n PMT
r
37
Annuity Due
Future Value:
(1 r ) n 1
FVA n PMT * (1 r )
r
Present Value:
1 (1 r ) n
PVA n PMT * (1 r )
r
38
Question
Suppose you save Rs.4,000 per year at the end of
each year for 3 years and earn 5% interest per
year. How much will you have at the end of 3
years? Using:
(1 r ) n 1
Data: FVA n PMT
r
PMT = Rs.4,000
(1 0.05) 3 1
n = 3 years FVA n 4,000
0.05
r = 5%
FVA n 4,000 3.1525
FV= ? FVA n Rs.12,610
39
Question
Suppose you save Rs.4,000 per year at the end of
each year for 10 years and earn 8.5% interest per
year. How much will you have at the end of 10
years? Using:
(1 r ) n 1
Data: FVA n PMT
r
PMT = Rs.4,000
(1 0.085)10 1
n = 10 years FVA n 4,000
0.085
r = 8.5%
FVA n 4,00014.8351
FV= ? FVA n Rs.59,340
40
Question
Suppose you save Rs.4,000 per year at the end of
each year for 3 years and earn 5% interest per
year. What will be the present value of your
savings? Using:
1 (1 r ) n
Data: PVA n PMT
r
PMT = Rs.4,000
1 (1 0.05) 3
n = 3 years PVA n 4,000
0.05
r = 5%
PVA n 4,000 2.7232
PV = ? PVA n Rs.10,893
41
Question
Suppose you save Rs.4,000 per year at the end of
each year for 10 years and earn 8.5% interest per
year. What will be the present value of your
savings? Using:
Data: 1 (1 r ) n
PVA n PMT
r
PMT = Rs.4,000
1 (1 0.085) 10
n = 10 years PVA n 4,000
0.085
r = 8.5%
PVA n 4,000 6.5614
PV = ? PVA n Rs.26,245
42
Question
Suppose you save Rs.4,000 per year at the
beginning of each year for 3 years and earn 5%
interest per year. How much will you have at the
end of 3 years? Using:
(1 r ) n 1
Data: FVA n PMT * (1 r )
r
PMT = Rs.4,000 (1 0.05) 3 1
FVA n 4,000 * 1 0.05
n = 3 years 0.05
r = 5% FVA n 4,000 3.1525 * 1.05
FV= ? FVA n Rs.13,240.5
43
Question
Suppose you save Rs.4,000 per year at the
beginning of each year for 10 years and earn 8.5%
interest per year. How much will you have at the
end of 10 years? Using:
(1 r ) n 1
Data: FVA n PMT * (1 r )
r
PMT = Rs.4,000 (1 0.085)10 1
* 1 0.085
n = 10 years FVA n 4,000 0.085
r = 8.5% FVA n 4,00014.8351 * 1.085
FV= ? FVA n Rs.64,384
44
Question
Suppose you save Rs.4,000 per year at the
beginning of each year for 3 years and earn 5%
interest per year. What will be the present value of
your savings? Using:
1 (1 r ) n
Data: PVA n PMT * 1 r
r
PMT = Rs.4,000 1 (1 0.05) 3
PVA n 4,000 * 1 0.05
n = 3 years 0.05
r = 5% PVA n 4,000 2.7232 * 1.05
PV = ? PVA n Rs.11,438
45
Question
Suppose you save Rs.4,000 per year at the
beginning of each year for 10 years and earn 8.5%
interest per year. What will be the present value of
your savings? Using:
Data: 1 (1 r ) n
PVA n PMT * 1 r
r
PMT = Rs.4,000
1 (1 0.085) 10
n = 10 years PVA n 4,000 * 1 0.085
0.085
r = 8.5%
PVA n 4,000 6.5614 * 1.085
PV = ? PVA n Rs.28,476
46
Loan Amortization
Q) What are the annual payments for a 4-year
Rs.4,000 loan if the interest rate is 9% per year?
How much the total amount of interest will be paid
against the loan? Make an amortization schedule.
Data:
PV = Rs.4,000
r = 9%
n = 4 years
PMT = ?
47
Calculation of PMT and Interest Payment
For
PMT (using formula):
PMT = Rs.1,235
48
Calculation of PMT and Interest Payment
49
Calculation of PMT and Interest Payment
50
Amortization Schedule
Loan
Year Pmt Interest Principal Balance
0 minus
9% of loan balance 4,000.00
1 1,235 360.00 874.67 ?
3,125.33
2 1,235 281.28 953.40 2171.93
3 1,235 195.47 1,039.20 1,132.73
4 1,235 101.95 1,132.73 -
51
Practice Questions
You need Rs.30,750 at the end of eight years,
bank is offering you 12 percent interest on your
deposit (compounded annually). How much
amount should you deposit each year?
Using Formula:
(1 r ) n 1
FVA n PMT
r
PMT = Rs.2,500
52
Practice Questions
You borrowed Rs.50,000 at the rate of 12 percent
interest for eight years. How much amount will you
pay each year to pay off this borrowing in eight
years?
Using Formula:
1 (1 r ) n
PVA n PMT
r
PMT = Rs.10,065
53
Retirement
You wish to retire in 40 years and planning to save
Rs.5,000 per year to accumulate enough amount
in order to live comfortably after retirement. How
much money will you have saved upon retirement,
If the interest rate is 6 percent.
Saving Period
…………….……….…………………………………………………..
0 40
PMT = 5,000
FV=?
r = 6%
54
Practice Questions
Using Formula:
(1 r ) n 1
FVA n PMT
r
(1 0.06) 40 1
FVA n 5,000
0.06
FVA n Rs.773,810
55
Practice Questions
You believe you will need to have saved
Rs.500,000 by the time you retire in 40 years in
order to live comfortably after retirement. If the
interest rate is 6 percent, how much must you save
each year to meet your retirement goal?
Saving Period
…………….……….…………………………………………………..
0 40
PMT = ? r = 6% FV=500,000
56
Practice Questions
Using Formula:
(1 r ) n 1
FVA n PMT
r
(1 0.06) 40 1
500,000 PMT
0.06
PMT Rs.3,230.77
57
Practice Questions
You have retired after 40 years and saved
Rs.500,000 in your account. How much amount
you will receive per year from the bank for 15
years to spend in your retired life, if the interest
rate is 10 percent.
Saving Period Spending Period
PMT Rs.65,737
59
Practice Questions
You believe you will need to spend Rs.50,000 a
year for 20 years after retirement at the age of 60
years. How much amount you will need to have in
your bank account to fulfill your retirement goal, if
the interest rate is 8 percent.
Saving Period Spending Period
PV Rs.490,907
61
Perpetuity
A perpetuity is an annuity with an infinite number
of cash flows.
62
Present Value of a Perpetuity
0 1 2 3 4 5 6 ………………n
Formula: PMT
PV
r
63
Present Value of a Perpetuity
Q) Find the present value of a perpetuity of
Rs.25,000 per year if the interest rate is 8% per
year.
PMT
PV
r
$25,000
PV $312,500
0.08
64
Nominal, Inflation & Real Rate
Formula:
1 Nominal Rate
1 Real Rate
1 Inflation Rate
Where;
Nominal Rate
Generally called “quoted rate”
Used in business transactions and in financial
activities
Includes Inflation rate.
65
Nominal, Inflation & Real Rate
Q) If the nominal rate is 10 percent, what will be
the real interest rate, if the inflation rate is 8
percent?
1 Nominal Rate
1 Real Rate
1 Inflation Rate
1 0.10 1.10
1 Real Rate
1 0.08 1.08
Real Rate 1.02 1 0.02
Real Rate 2%
66
Nominal, Inflation & Real Rate
Q) If the nominal rate is 10 percent, what will be
the real interest rate, if the inflation rate is 12
percent?
1 Nominal Rate
1 Real Rate
1 Inflation Rate
1 0.10 1.10
1 Real Rate
1 0.12 1.12
Real Rate 0.98 1 0.02
Real Rate 2%
67
Nominal, Inflation & Real Rate
Q) If the nominal rate is 10 percent, what will be
the real interest rate, if the inflation rate is 0
percent?
1 Nominal Rate
1 Real Rate
1 Inflation Rate
1 0.10 1.10
1 Real Rate
1 0 1
Real Rate 1.1 1 0.1
Real Rate 10%
68