Time Value

Of
Money
Time Value of Money
 Time preference for money is an individual’s
preference for possession of a given amount
of money now, rather than the same amount
at some future time.
Reasons:
◦ Risk
◦ Preference for consumption
◦ Investment opportunities
Required Rate of Return
 Minimum rate of return which should be earn
on an investment

Required Rate Of Return= Risk Free Rate

+ Risk Premium
Time Value Adjustment
 Compounding:
It is the process of calculating future values
of cash flows.

 Discounting:
It is the process of calculating present values
of cash flows.
Future Value
 Compounding is the process of finding the

future values of cash flows by applying the

concept of compound interest.
FV = PV (1 + i)n

Future Value of Annuity

 Annuity is a fixed payment or receipt each
year for a specified number of years
FVn = P [((1 + i)n - 1) / i]
Present Value
Present value is a future cash flow (inflow or
outflow) is the amount of current cash that is
of equivalent value of the decision maker.

 Discounting is the process of determining

present value of a series of future cash flows.

 The interest rate used for discounting cash

flows is also called the discount rate.
Present Value of Single Cash Flow:

PV = FV/(1 + r)n

Present Value of Annuity:

PVoa = Fn[(1 - (1 / (1 + i)n)) / i]

Present Value of Perpetuity
 Perpetuity is an annuity that occurs

indefinitely. Perpetuities are not very common

in financial decision making.
Present value of perpetuity= Perpetuity/i

Present Value of growing annuity

Value of an Annuity Due
 Annuity due is a series of fixed receipt or
payments starting at the beginning of each
period for a specified number of periods.

Future value of an annuity due:

FV(AD) = P*cvfa (n,i) (1 + i)

Present value of an annuity due:

PV(AD) =fn *pvaf(n,i) (1+i)
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