TIME VALUE OF MONEY

FINANCIAL MANAGEMENT
Why money has time value?
1.Inflation
2.Earning Power of Money
3.Uncertainty
Future Value of Single Amount
( FV )=PV × ( 1+r )n
FV= Future Value
PV = Present Value
r= Interest rate/return
n= number of periods/years

Example: If you deposit Rs. 1000 in a bank at a

rate of 10% p.a. for 10 years, what will you get
after 10 years?
ANS ( FV )=PV × ( 1+ r ) n

( FV )=1000 × ( 1+0.10 )10=Rs .2593 .7

Present Value of Single Amount

( PV )=FV ÷ ( 1+r )n

Example: You are going to receive Rs. 2000000

after 30 years. What is the present value today if
the rate of interest in the market is 10%
ANS
FV= Future Value=2000000
PV = Present Value=?
r= Interest rate/return= 10%
n= number of periods=30 years
( PV )=FV ÷ ( 1+r )n
( PV )=2000000 ÷ (1+.1 )30

=Rs. 114617

Example: You are given two options; Rs. 100 today

or Rs. 150 after 4 years. If the rate of interest in
bank is 9%, which option will you select?
ANS: PV of second option=150/(1.09)^4= 106.3
which is higher than first option(Rs.100) therefore
option-2 is better

Future Value of Annuity

 (1+r )n−1
( FVA )=A { r }
Example: What will you get after 7 years if you
deposit Rs. 10000 every year at a rate of 10% p.a..
ANS:
FVA=Future Value of Annuity
A= Annuity=10000
R=rate of interest/return=.10
N=no. of periods=7
( 1+.1 )7−1
( FVA )=10000
0.1 { =Rs .94871 }
Example: You will need Rs. 1000000 after 5 years.
What amount you must deposit in a bank account
for next 5 years in order to get Rs. 1000000 after 5
years? The bank offers 10% interest.
ANS:
FVA=Future Value of Annuity (Given)= Rs. 1000000
A= Annuity(Missing)=?
R=rate of interest/return=10%=0.10
N=no. of periods=5
( 1+r )n −1
( FVA )= A { r }
(1+0.10)5−1
1000000= A { 0.10 }
A=Rs . 163797 evey year

Present Value of Annuity

 ( 1+r )n −1
( PVA )= A
{ r × (1+ r )n }
Example:
What loan amount you can avail today if you are
able to pay an instalment of Rs. 300000 p.a. for
next 4 years. Assume that the rate of interest is
10% p.a.
ANS
Annuity=Maximum instalment you can pay=300000 p.a.=A
How many years = 4 yrs=n
Rate of interest =10%=r
Present Value of Annuity= What loan amount can you get?
=PVA

( 1+.1 )4 −1
( PVA )=300000
{ .1 × ( 1+.1 )4 }
Rule of 72
It talks about doubling period. Money gets double in 72/r
years(where r is the rate of interest)
Assume that the rate of interest is 10% therefore money will
get double in 72/10=7.2 yrs

n
1+ g
Present Value of Growing Annuity=A 1× { 1− ( )
1+r
r −g
}
Where A 1= A 0 × (1+ g )

Example:
Current salary=A0=Rs.1000000 p.a.
G= growth Rate =10%=0.1
A1=Annuity next year= 1100000
R=Discount Rate= 12%=0.12
N=Time period=remaining earning life=30 years
What is the value of the person’s life time
earnings
1+0.1 30
1000000 X (1.10){1− (1+.12
0.12−0.11
}
) =2.29 Crore

Example:- Mining Example

Current Production=1000 units
Current Price= Rs. 100
A0=100000 A1=100000 X (1.06)=110000
Number of years = 10
Growth in price = 6% p.a.
r=10%
What price can be paid for the mining rights?
1+ 0.06 10
100000 X (1.06) { 1− (
1+.10
0.10−0.06
}
) =Rs. 820309

Present Value of Perpetuity

PV= P/r
10000=1000/0.10

Present Value of Growing Perpetuity

PV= P1/(r-g) = P0 X(1+g)/(r-g)

10000=1000/0.10
Annuity Due
PV FV
Year 0 1 2 3 4 5
Normal Annuity   A A A A A

PV FV
Year 0 1 2 3 4 5
Annuity Due A A A A A  

IN CASE OF ANNUITY DUE, THE ANSWER IS TO BE

MULTIPLIED WITH (1+R), For Ex.:
Future Value of Annuity Due
(1+r )n−1
( FVA )=A { r }×(1+r )❑
Present Value of Annuity Due
(1+r )n−1
( PVA )=A
{
r ×(1+ r)}
n
×(1+r )❑

Effective Vs. Stated rate

Rate of Interest is 12% p.a.. What is the effective annual rate?
ANS=12% p.a.
Ex.: Rate of Interest is 12% p.a., compounded semi-annually . What is
the effective annual rate? ANS= 12.36%
Effective rate = (1+stated rate/m)m-1, where m is the frequency of
compounding
=(1+0.12/2)2-1=0.1236 = 12.36%

Ex.: Rate of Interest is 12% p.a., compounded Monthly. What is the

effective annual rate? ANS= =(1+0.12/12)12-1=0.1268 = 12.68%

Real Vs. Nominal Rate

Rate of interest is 10% pa and inflation is 6% pa. What are
Nominal and real rates?
Nominal: 10%
Real Rate: {(1+Nominal rate)/(1+ Inflation rate)}-1
Real Rate: {(1.10)/(1.06)}-1
 (1+r)n-1
Future Value of Annuity= AX
r

Practice Problems
1.You can save Rs. 3000 a year for 5 years and
Rs. 8000 a year for 10 years thereafter. What
will these savings cumulate to at the end of 15
years, if the interest rate is 10% p.a.?
(1+r)n-1
Future Value of Annuity= AX
r

=3000 X FVA Eq. X (1+r)^10 + 8000 X FVA

Eq.=Rs.1,75,000
2. Mr. Mehta plans to send his son for higher
education after 8 years. He expects the cost
of these studies to be Rs. 20,00,000. How
much should he save annually to meet the
requirement? Assume rate of 8% p.a.

FVA = A X {(1+r)n-1}/{r}
20,00,000 = A X {(1+0.08)8-1}/{0.08} = 188029
3.At the time of retirement, Mr. Shah is given
two options; (i) An annual payment of
Rs.200000 as long as he lives,
(ii) A lumpsum amount Rs. 20,00,000 today. If
Mr. Shah expects to live for 15 years and the
interest rate is 8%, which option should he
choose?
ANS: Compute the present value of annuity of
Option-1 and compare it with the second one
Present value of Option-I [A= 200000 pa, r=
8%, n=15]
PVA = A X {(1+r)n – 1}/{r X (1+r)n}
PVA = 200000 X {(1.08)15 – 1}/{0.08 X (1.08)15}
=1711895 (Present value of Option-1)
17,11,895 < 20,00,000, option-2 is better
4.Ms. Janki deposits Rs. 50,00,000 in a bank that
pays 10% interest. How much can she
withdraw annually for a period of 20 years.
Assume that after 20 years the account
balance will become zero
PVA=5000000, r=0.1, n=20yrs

PVA = A X {(1+r)n – 1}/{r X (1+r)n}

5000000 = A X {(1.1)20 – 1}/{0.10 X (1.10)20}
A = Rs. 587298
 5.What is the present value of an income
stream that provides Rs. 1,00,000 at the end
of each of year 1 through year-3, Rs. 3,00,000
at the end of each of year 4 through year-6
and Rs. 5,00,000 every year, forever
thereafter? The interest rate is 10%.
=100000X{(1.1)3 -1}/{r x (1.13)}
Plus 300000X{(1.1)3 -1}/{r x 1.13} X
1/(1.10)3
Plus {500000/0.10} /1.106
Year Cash Flow Present Value Present Value
1 100000 100000/(1.1)^1 90909.09091
2 100000 100000/(1.1)^2 82644.6281
3 100000 100000/(1.1)^3 75131.48009
4 300000 300000/(1.1)^4 204904.0366
5 300000 300000/(1.1)^5 186276.3969
6 300000 300000/(1.1)^6 169342.179
Present Value of the cash flows to be received
809208 during first 6 years
7TH YR ONWARDS Rs. 500000
every year  

500000/0.1 Why? Present value of perp amt = Amt/r

5000000 This will be the present value after 6 years
why?
because the cash flow will begin from the end of
year 7
Total Present Value= What is the pv today?
3631577 =50,00,000/1.1^6
2822369
6. What amount must be deposited today in
order to earn an annual income of Rs.
2,00,000 starting from the end of 12 years
from now and continuing for 10 years
thereafter? The deposit earns 10 percent per
year.
ANS
The present value of annuity after 11 years
=200000 X {(1.1)10 -1}/{1.110 X 0.10}=1228913
So what is the present value today?
Present value after 11 years divided by (1+r)11
=1228913/(1.10)^11=430726
7.If the interest rate is 10 percent how much
investment is required now to yield an income
of Rs.1,00,000 per year from the beginning of
the 10th year and continuing thereafter
forever?
Present value of perp. after 8
years=100000/0.1=rs. 10,00,000
The PV of any cash flow stream is one year
before the starting date
So, What is the PV TODAY?
PV Today = PV after 8th year/(1.1)8
=10,00,000/1.18 = Rs.466507
 8.How much should be deposited at the
beginning of each year for 5 years in order to
provide a sum of Rs. 200000 at the end of 5
years ? The rate is 10%
Ans: 29781 (32759 is wrong)
200000 = A X {(1.15 -1)/(0.1X1.15)} X 1.1
A= 29781
9.A person requires Rs. 90000 at the end of
each year from 2031 to 2037. How much
should he deposit at the end of each year
from 2021 to 2026? The interest rate is 12
percent.
Year  
0 2020  
1 2021 A? Apply the concept of future value of
2 2022 A? annuity to compute A (32165)
3 2023 A? [FVA=y, r=12%, n=6
4 2024 A?
5 2025 A?
6 2026 A? What amount is needed here?(y)
Y(261031) is the present value of x
7 2027  
(r=12%, n=4)
8 2028  
9 2029  
10 2030   What amount is needed here? (x)
X(410738) is the present value of 90000
11 2031 90000
annuity(r=12%, n=7)
12 2032 90000
13 2033 90000
14 2034 90000
15 2035 90000
16 2036 90000
17 2037 90000
10. A person requires Rs. 90000 at the
beginning of each year from 2031 to 2037.
How much should he deposit at the end of
each year from 2021 to 2026? The interest
rate is 12 percent.
Year  
0 2020  
1 2021 A? Apply the concept of future value of
2 2022 A? annuity to compute A (40348)
3 2023 A? [FVA=y, r=12%, n=6]
4 2024 A?
5 2025 A?
6 2026 A? What amount is needed here?(y)
7 2027   Y is the present value of x (r=12%, n=3)
8 2028  
9 2029   What amount is needed here? (x)
X() is the present value of 90000
10 2030 90000
annuity(r=12%, n=7)
11 2031 90000
12 2032 90000
13 2033 90000
14 2034 90000
15 2035 90000
16 2036 90000