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TVM-Practical Questions

The document discusses concepts and techniques of time value of money (TVM), including compound interest, present value, future value, and annuities. It provides examples of calculating future and present values over various time periods using common TVM formulas. Additional examples demonstrate calculating implicit interest rates and equal installment loans using TVM principles.

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parag nimje
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85 views6 pages

TVM-Practical Questions

The document discusses concepts and techniques of time value of money (TVM), including compound interest, present value, future value, and annuities. It provides examples of calculating future and present values over various time periods using common TVM formulas. Additional examples demonstrate calculating implicit interest rates and equal installment loans using TVM principles.

Uploaded by

parag nimje
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Concepts/Techniques of TVM

1) Compound value concept


a) Compounding of interest over ‘N’ years
b) Multiple compounding periods
c) Future value of series of cash flows
d) Compounding annuities
2) Present Value/Discounting concepts
a) PV after ‘N’ years
b) PV of a series of cash flows
c) PV of an annuity
d) PV of a perpetual annuity

Compound value Techniques

a) Compounding of interest over ‘N’ years


A=P(1+i)n
A=Amount at the of end of period ‘n’
P=Principal at the beginning of period
i=interest rate
n=number of years
Problem: If Rs.1,000 are invested at 10% compounded annually for 25
years, calculate the compound value.
Solution
A=P(1+i)n
A=1,000(1+0.1)25
=1,000*10.835

=10,835

b) Multiple compounding periods


A=P(1+i/m)m*n
m=number of times per year compounding is made
Problem: If Rs.1,000 are invested for 3 years and the interest is
compounded at 10% p.a. semi annually, calculate the compound
value.
Solution

A=P(1+i/m)m*n
A=1,000 (1+0.05)2*3
A=1,000 (1+0.05)6
A=1,000*1.340
=1,340
c) Future value of series of cash flows
Problem: Mr. X invests Rs.500, Rs. 1,000 and Rs.2,000
at the end of each year. Calculate the compound value at
the end of 3 years compounded annually when interest is
charged at 10% p.a.
Solution

End of Amount No. of years Compound Future value


year deposited compounde interest (Amount
d factor (CIF) deposited*CIF)
1 500 2 1.210 605
2 1,000 1 1.100 1,100
3 2,000 0 1.000 2,000
Amount at the end of third year 3,705
d) Compounding annuities-A series of equal cash flows occurring
over equally spaced points in time. or
Equal cash flows occurring at equal intervals
Problem: Find the compound value when three equal yearly
payments of Rs.2,000 are deposited into an account, that yields
7% compound interest.
Solution
Compound value of Re.1 annuity-3.125
Compound value of Rs.2,000 annuity-3.125*2,000
=6,250
A=P(1+i)n
[2,000 (1+0.07)3] +[2,000 (1+0.07)2]+ [2,000 (1+0.07)1]
Discounting/PV techniques
a) PV after ‘n’ years
PV=A/(1+i)n

A=P(1+i)n
PV-Principal Amount the investor is willing to forgo at present
Problem:Mr.X expects to get Rs.1,000 after one year At the
rate of 10%. Calculate the amount he will have to forego at
present.
Solution
PV=A/(1+i)n
1,000/1+0.1)1=909.1
By table PV of Re. 1 after 1 year=0.909
PV of Rs. 1,000 after 1 year=0.909*1,000=909
b) PV of a series of cash flows
By Formula
PV=[A1/(1+i)1]+ [A2/(1+i)2]+ [A3/(1+i)3]+------+[An/(1+i)n]
A1, A2 A3=Cash flows after period 1, 2, 3,etc.
Problem:Given the TVM as 10% (i.e. discounting factor),
Calculate PV from the following information.
Year Cash Flows (Rs.)
1 1,000
2 2,000
3 3,000
4 4,000
Solution
PV of Cash Flows
Year Cash Flows PVF at 10% PV
1 1,000 0.909 909
2 2,000 0.826 1,652
3 3,000 0.751 2,243
4 4,000 0.683 2,732
PV of series of cash flows 7,546

c)PV of an annuity
Problem: Calculate the PV of Rs.500 received annually for 4
years when discount factor is 10%.
Solution
PVAn=A*ADF
PVAn=PV of an annuity having a duration of ‘n’ periods
A=Value of single instalment
ADF=Annuity Discount Factor
or
PV of Re.1 received annually for 4 years-3.170
PV of Rs.500 received annually for 4 years-3.170*500
=1,585
d)PV of an perpetual annuity
PV of Perpetuity=A/i
Problem: Mr.X intends to have a return of Rs.10,000 p.a.for
perpetuity. Calculate the PV of this perpetuity taking
discount rate at 10% .
Solution
PV of Perpetuity=10,000/0.1
=1,00,000
Additional Questions
Problem: A company offers to refund an amount of 44,650
at the end of five years for a deposit of Rs, 6,000 made
annually. Find out the implicit rate of interest offered by the
company.
Solution
44,650=6,000*CVAF (i%, 5y)
44,650/6,000=CVAF (i%, 5 y)
7.442= CVAF (i%, 5 y)

On referring to CVAF Table, the value 7.442corresponding


to 5 years row is found in 20% column. Hence the implicit
rate of interest is 20%
Problem: Vijay borrows from Bank an amount of Rs.10,00,000 at 12%
p.a. on 1.4.2012. The repayment including interest is to be made in 5
equal annual installments with first installment falling due after 3 years
i. e. on 31.3.2015. What would be the amount of each installment?
Solution
Total amount due at the end of 2nd year i.e. in the beginning of third year
FV=PV(1+i)n
By table
10,00,000*1.254
=12,54,000
12,54,000 is the PV of annuity of 5 year period at 12%
interest.
Amount of annuity
PV=A*ADF
12,54,000=A*3.605
12,54,000/3.605=A
3,47,850

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