Time Value of Money/Mathematics of

Finance
Meaning of time value of money
The value of money received today is more than the same amount of money to be received after 1
year. Money received at different points of time possesses different values.

Reasons for time preference for money or reasons for the

time value of money
1. Risk or future uncertainties: Risk is defined as the variability in the cash flows. That is to
say, if there is difference between the expected cash flows and the actual cash flows, then we
can say that there is an element of the risk. There is always an uncertainty about the receipt
of the money in the future. Money received today is certain but any money which is
receivable in future has some risk attached to it. Rational human being will prefer to receive
the money today because it is certain but the money promised to be paid after one year is
uncertain.
2. Preference for present consumption: If any individual is given with a choice of receiving
the money either today or a year later, every rational human being will prefer to receive it
today. The present needs to purchase food, clothes and other items are urgent as compared
to other needs. So, this is a reason that people prefer money for present consumption.
3. Inflation: Purchasing power of the money declines due to inflation. Suppose, today a person
can buy 1 kilogram of wheat with ₹10 and if the rate of inflation is 10% per annum, then the
price of wheat will be ₹11 per kilogram after one year. In such a case that person will not be
able to buy the same quantity of wheat with ₹10 after 1 year. Due to the inflation or
reduction in the purchasing power of the money people want to buy goods and services now
even with the less money but more benefits.
4. Reinvestment opportunities: Every person has a preference for the present money
because there are always available some investment opportunities. For example—If a
person has ₹5,000 today then he can invest that money in bank/shares/debentures/etc.
Suppose the rate of return is 12% per annum then he will get ₹5,600 a year later. But he
must get this amount today so that he can invest. This extra money (reinvestment
opportunity) is a motive for him to receive the money today and not later. Every rational
human being is supposed to prefer for the present money.

Chapter 2, Time Value of Money: 1

Formulae
Future value of a single present cash flow
𝐹𝑉 = 𝑃𝑉(1 + 𝑟) 𝑛
Where,
𝐹𝑉 = Future value
𝑃𝑉 = Present value
𝑟 = Rate of interest
𝑛 = Number of years
Note:
In case compounding is done more than once a year then 𝑟 shall be divided by the number of
compounding in a year and 𝑛 shall be multiplied with number of compounding in a year.

Present value of a future sum

𝐹𝑉
𝑃𝑉 =
(1 + 𝑟) 𝑛
Where,
𝐹𝑉 = Future value
𝑃𝑉 = Present value
𝑟 = Rate of interest
𝑛 = Number of years
Note:
In case compounding is done more than once a year then 𝑟 shall be divided by the number of
compounding in a year and 𝑛 shall be multiplied with number of compounding in a year.

Effective rate of interest

Effective rate of interest is the rate of interest under annual compounding, which provides
the same future value as provided by annual interest rate compounded more than once in a
year.
𝑟 𝑚
𝑟𝑒 = [1 + ] − 1
𝑚
Where,
𝑟 = Rate of interest
𝑚 = Number of compounding in a year

Future value of a series of equal cash flows over a period of time or

future value of an annuity
(1 + 𝑟) 𝑛 − 1
𝐹𝑉𝐴 = 𝑃𝑉 × [ ]
𝑟
Where,
𝐹𝑉𝐴 = Future value of annuity
𝑃𝑉 = Present value of a single cash flow
𝑟 = Rate of interest
𝑛 = Number of years
Note: If nothing is mentioned then it is assumed that cash flows occur at the end of each period.

Future value of a series of equal cash flows (occurring at the

beginning of period) over a period of time or future value of an annuity
due
(1 + 𝑟) 𝑛 − 1
𝐹𝑉𝐴 = 𝑃𝑉 × [ ] × (1 + 𝑟)
𝑟
Where,
𝐹𝑉𝐴 = Future value of annuity due
Chapter 2, Time Value of Money: 2
 𝑃𝑉 = Present value of a single cash flow
𝑟 = Rate of interest
𝑛 = Number of years
Note:
In case compounding is done more than once a year then 𝑟 shall be divided by the number of
compounding in a year and 𝑛 shall be multiplied with number of compounding in a year.

Present value of a series of equal cash flows over a period of time or

present value of an annuity/calculation of installment/EMI
Whenever we want to calculate the installment then we calculate the present value of a series of
equal cash flows occurring at the end of each period. Formula is—

1
1−
(1 + 𝑟) 𝑛
𝑃𝑉𝐴 = 𝐹𝑉 𝑜𝑟 𝐴 × [ ]
𝑟

Where,
𝑃𝑉𝐴 = Present value of annuity
𝐹𝑉 𝑜𝑟 𝐴 = Single cash flow or Annual installment or half yearly installment or quarterly
installment or equated monthly installment (EMI)
𝑟 = Rate of interest
𝑛 = Number of years or number of payment periods
Notes:
1. In case the installment is annual then no change in the number of periods and rate of
interest is required.
2. In case the installment is bi-annually then number of periods shall be calculated by
multiplying the years with 2 and rate of interest shall be calculated by dividing it by 2.
3. In case the installment is quarterly then number of periods shall be calculated by
multiplying the years with 4 and rate of interest shall be calculated by dividing it by 4.
4. In case of EMI the number of periods shall be calculated by multiplying the years with 12
and rate of interest shall be calculated by dividing it by 12.

Present value of a series of equal cash flows (occurring at the

beginning of period) over a period of time or present value of an
annuity due
1
1−
(1 + 𝑟) 𝑛
𝑃𝑉𝐴 = 𝐹𝑉 𝑜𝑟 𝐴 × [ ] × (1 + 𝑟)
𝑟

Where,
𝑃𝑉𝐴 = Present value of annuity due
𝐹𝑉 𝑜𝑟 𝐴 = Single cash flow
𝑟 =Rate of interest
𝑛 = Number of years
Notes:
1. In case the installment is annual then no change in the number of periods and rate of
interest is required.
2. In case the installment is bi-annually then number of periods shall be calculated by
multiplying the years with 2 and rate of interest shall be calculated by dividing it by 2.
3. In case the installment is quarterly then number of periods shall be calculated by
multiplying the years with 4 and rate of interest shall be calculated by dividing it by 4.
4. In case of EMI the number of periods shall be calculated by multiplying the years with 12
and rate of interest shall be calculated by dividing it by 12.

Present value of a perpetuity

Perpetuity is an infinite series of equal cash flows.
Chapter 2, Time Value of Money: 3
 𝐴
𝑃𝑉𝑝 =
𝑟
Where,
𝐴 = Annuity or single cash flow
𝑟 = Rate of interest
Note:
A perpetuity is defined as an infinite series of equal cash flows occurring at regular time intervals.

Present value of a perpetuity growing a constant rate

𝐶𝐹1 𝑜𝑟 𝐴
𝑃𝑉𝑝 =
(𝑟 − 𝑔)
Where,
𝐶𝐹1 𝑜𝑟 𝐴 = Single cash flow
𝑟 = Rate of interest
Notes:
1. Present value of a growing perpetuity is mathematically equivalent to the sum of an infinite
geometric series.
2. This formula is only correct when 𝑟 > 𝑔. If 𝑟 = 𝑔 or if 𝑟 < 𝑔, then the PV is infinite and it
cannot be determined.

Present value of an annuity growing at a constant rate

𝐶𝐹1 𝑜𝑟 𝐴 1 +𝑔 𝑛
𝑃𝑉𝐴 = [1 − ( ) ]
(𝑟 − 𝑔) 1 +𝑟
Where,
𝐶𝐹1 𝑜𝑟 𝐴 = Single cash flow
𝑟 = Rate of interest
𝑔 = Growth rate
𝑛 = Number of years
Note:
Perpetuity is infinite series whereas annuity is finite series.

Present value of an annuity growing at a constant rate provided, r=g

𝑛
𝑃𝑉𝐴 (𝑝𝑟𝑜𝑣𝑖𝑑𝑒𝑑, 𝑟 = 𝑔) = 𝐶𝐹1 𝑜𝑟 𝐴 ×
(1 + 𝑟)
Where,
𝐶𝐹1 𝑜𝑟 𝐴 = Single cash flow
𝑟 = Rate of interest
𝑛 = Number of years

Calculation of r
1
𝐹𝑉 𝑛
𝑟 = [ ] −1
𝑃𝑉
Where,
𝑟 = Rate of interest
𝐹𝑉 = Future value
𝑃𝑉 = Present value
𝑛 = Number of years

Chapter 2, Time Value of Money: 4

Illustration
Example 1
Mr. Robert deposits ₹50,000 at 6% p.a. interest for five years compounded annually. How much
would he get at the end of fifth year?

Solution:
FV = 𝑃𝑉(1 + 𝑟)𝑛
= 50,000(1 + 0.06)5
= 50,000(1.06)5
= 50,000 × 1.338
= ₹66,900

Example 2
Ms. Yasmeen deposits ₹10,000 for a period of 3 years at 8% p. a. interest compounded half-yearly.
What will be the total amount after 3 years?

Solution
r = 0.08/2 = 0.04
n = 3 𝑌𝑒𝑎𝑟𝑠 × 2 = 6 𝑃𝑒𝑟𝑖𝑜𝑑𝑠

FV = 𝑃𝑉(1 + 𝑟)𝑛
= 10,000(1 + 0.04)6
= 10,000(1.04)6
= 10,000 × 1.265
= ₹12,650

Example 3
Mr. Zenith deposits ₹20,000 for a period of 2 years at 8% p. a. interest compounded quarterly. What
will be the total amount after 2 years?

Solution
r = 0.08/4 = .02
n = 2 𝑌𝑒𝑎𝑟𝑠 × 4 = 8 𝑃𝑒𝑟𝑖𝑜𝑑𝑠

FV = 𝑃𝑉(1 + 𝑟)𝑛
= 20,000(1 + 0.02)8
= 20,000(1.02)8
= 20,000 × 1.172
= ₹23,440

Example 4
A 5-year annuity of ₹60,000 per year is deposited in a bank that pays 8% p. a. interest compounded
yearly. Find out the total amount available to the depositor at the end.

Solution
(1+𝑟) 𝑛−1
FVA = 𝑃𝑉 × [ ]
𝑟
(1+0.08) 5−1
= 60,000 × [ ]
0.08
= ₹3,51,996

Chapter 2, Time Value of Money: 5

Example 5
A company has issued bonds of ₹60,00,000 to be repaid after 7 years. How much should the
company invest in a sinking fund earning 12% p. a. in order to be able to repay the bonds?

Solution
(1+𝑟) 𝑛−1
FVA = 𝑃𝑉 × [ ]
𝑟
(1+0.12) 7−1
60,00,000 = 𝑃𝑉 × [ ]
0.12
PV = ₹5,94,706
So, company needs to invest ₹5,94,706 in the sinking fund at the end of every year.
Note:
In the sinking fund investment is made at the end of every year, so, it is a case of annuity.

Example 6
Mr. Raju deposits ₹2,00,000 at the beginning of each year in a bank which earns a compound
interest of 8% p. a. Find out the amount he will get at the end of 5th year.

Solution
In this question it is given that Raju deposits ₹2,00,000 at the beginning of each year, so it is a case
of annuity due.
(1+𝑟) 𝑛−1
FVA = 𝑃𝑉 × [ ] × (1 + 𝑟)
𝑟
(1+0.08) 5−1
= 2,00,000 × [ ] × (1 + 0.08)
0.08
= 2,00,000 × 5.867 × (1 + 0.08)
= ₹12,67,272

Example 7
Mr. Rao will receive ₹2,500 annually for 5 years. If interest rate is 9% p. a. find out the present value
of annuity.

Solution
1
1−(
1+𝑟)𝑛
PVA = 𝐹𝑉 × [ ]
𝑟
1
1−(
1+0.09) 5
= 2,500 × [ ]
0.09
= 2,500 × 3.890
= ₹9,725

Example 8 GOOD
Ms. Leena took a loan of ₹2,50,000 at an interest rate of 7.80% p. a. for a period of 1 year. What
would be the EMI?

Solution
The loan amount of ₹2,50,000 is the present value of an annuity as she is receiving the total amount
at present (today). The EMI is the future value (single cash flow) that she will pay every month for a
period of 1 year. Let us calculate the EMI—
0.078
r = = 0.0065
12
n = 1 𝑌𝑒𝑎𝑟 × 12 = 12
1
1−(
1+0.0065)12
PVA = 𝐹𝑉 𝑜𝑟 𝐴 𝑜𝑟 𝐸𝑀𝐼 × [ ]
0.0065
2,50,000 = 𝐹𝑉 𝑜𝑟 𝐴 𝑜𝑟 𝐸𝑀𝐼 × 11.5080
FV or A or EMI = ₹21,724
Chapter 2, Time Value of Money: 6
VERIFICATION
Principal Amount or Balance at the end of each
Opening balance at the Interest month
beginning of each month (Balance at the beginning (Opening
or balance at the end of of each Balance+Interest-EMI i.e.
Month previous month month7.8/1001/12) ₹21,724)
1 2,50,000.00 1,625.00 2,29,901.00
2 2,29,901.00 1,494.36 2,09,671.36
3 2,09,671.36 1,362.86 1,89,310.22
4 1,89,310.22 1,230.52 1,68,816.74
5 1,68,816.74 1,097.31 1,48,190.05
6 1,48,190.05 963.24 1,27,429.28
7 1,27,429.28 828.29 1,06,533.57
8 1,06,533.57 692.47 85,502.04
9 85,502.04 555.76 64,333.80
10 64,333.80 418.17 43,027.97
11 43,027.97 279.68 21,583.65
12 21,583.65 140.29 -0.060
For 2nd month onwards the principal amount is the balance at the end of previous month.

Example 9
Mr. Xin Ping purchased a house under a housing scheme valued at ₹24,00,000. Under the provisions
of the scheme, Xin Ping agreed to pay the amount through ten equal annual installments. What is
the amount of the annual installment if the rate of interest is 12% p. a.?

Solution
1
1−(
1+0.12)10
PVA = 𝐹𝑉 𝑜𝑟 𝐴 𝑜𝑟 𝐸𝑀𝐼 × [ ]
0.12
24,00,000 = 𝐹𝑉 𝑜𝑟 𝐴 𝑜𝑟 𝐸𝑀𝐼 × 5.65022302858
FV or A or EMI  ₹4,24,762
VERIFICATION
Balance at the end of each
Principal Amount or month
Opening balance at the (Opening
beginning of each month Interest Balance+Interest-Equal
or balance at the end of (Balance at the beginning Annual Installment i.e.
Month previous month of each month12/100) ₹4,24,762)
1 24,00,000.00 2,88,000.00 22,63,238.00
2 22,63,238.00 2,71,588.56 21,10,064.56
3 21,10,064.56 2,53,207.75 19,38,510.31
4 19,38,510.31 2,32,621.24 17,46,369.54
5 17,46,369.54 2,09,564.35 15,31,171.89
6 15,31,171.89 1,83,740.63 12,90,150.52
7 12,90,150.52 1,54,818.06 10,20,206.58
8 10,20,206.58 1,22,424.79 7,17,869.37
9 7,17,869.37 86,144.32 3,79,251.69
10 3,79,251.69 45,510.20 -0.110

Example 10 GOOD
Mr. Heera purchased a house under a housing scheme valued at ₹24,00,000. Under the provisions of
the scheme, Mr. Heera agreed to pay a part of the amount through ten equal installments of
₹2,50,000 involving effective rate of interest of 12%. Find the cash down payment required to be
made by Mr. Heera to pay the total price of the house?
(B. Com. Honors, Delhi University, 2015)

Chapter 2, Time Value of Money: 7

Solution
Present value of 10 equal installments of ₹2,50,000 each paid by Mr. Mr. Heera—
1
1−(
1+0.12)10
PVA = 𝐹𝑉 𝑜𝑟 𝐴 𝑜𝑟 𝐴𝑛𝑛𝑢𝑎𝑙 𝐼𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡 × [ ]
0.12
1
1−(
1+0.12)10
= 2,50,000 × [ ]
0.12
= 2,50,000 × 5.65022302858
 ₹14,12,556

Total value of the house = ₹24,00,000

Less: PV of 10 equal annual installments of ₹2,50,000 each = ₹14,12,556
Cash down payment required to be made by Mr. Heera = ₹9,87,444
VERIFICATION
Balance at the end of each
Principal Amount or Opening Interest month
balance at the beginning of (Balance at the (Opening Balance+Interest-
each month or balance at the beginning of each Equal Annual Installment
Month end of previous month month12/100) i.e. ₹2,50,000)
24,00,000-9,87,444 (Cash
down payment)
1 =₹14,12,556.00 1,69,506.72 13,32,062.72
2 13,32,062.72 1,59,847.53 12,41,910.25
3 12,41,910.25 1,49,029.23 11,40,939.48
4 11,40,939.48 1,36,912.74 10,27,852.21
5 10,27,852.21 1,23,342.27 9,01,194.48
6 9,01,194.48 1,08,143.34 7,59,337.82
7 7,59,337.82 91,120.54 6,00,458.35
8 6,00,458.35 72,055.00 4,22,513.36
9 4,22,513.36 50,701.60 2,23,214.96
10 2,23,214.96 26,785.80 0.75

Example 11
Mr. Ramesh has rented out a portion of his house for 4 years at an annual rent of ₹6,000 with the
stipulation that rent will increase by 10% every year. If the required rate of return is 15%, what is
the present value of the expected series of rent?

Solution:
Present value of an annuity growing at a constant rate
𝐶𝐹1 𝑜𝑟 𝐴 1 +𝑔 𝑛
𝑃𝑉𝐴 = [1 − ( ) ]
(𝑟 − 𝑔) 1 +𝑟
Where,
𝐶𝐹1 𝑜𝑟 𝐴 = Single cash flow
𝑟 = Rate of interest
𝑔 = Growth rate
𝑛 = Number of years
𝐶𝐹1 𝑜𝑟 𝐴 1 +𝑔 𝑛 6,000 1 + 0.10 4
𝑃𝑉𝐴 = [1 − ( ) ]⇒ × [1 − ( ) ] ⇒ ₹19,548
(𝑟 − 𝑔) 1 +𝑟 0.15 − 0.10 1 + 0.15

Alternate solution
Statement of Calculation of Present Value
Year Present Value Factors Present Value (PV) of
end Cash Inflows (₹) (PVF) at 15% Cash Inflows (₹)

Chapter 2, Time Value of Money: 8

 1 6,000 0.870 5,220
2 (6,000  1.10) = 6,600 0.756 4,990
3 (6,600  1.10) = 7,260 0.658 4,777
4 (7,260  1.10) = 7,986 0.572 4,568
Total Present Value 19,555

Example 12
GOOOD Mr. B will require ₹30,00,000 after 10 years from now. He wants to ascertain an amount to be
invested in a fund which pays interest @ 10% per annum. Following options are available to him—
(i) To make annual payment into the fund at the end of each year.
(ii) To invest a lump sum amount in the fund at the end of the first year.
(iii) To make annual payment into the fund in the beginning of each year.
Find out the amount to be invested under each of the options given above.

Solution
Given, Future value ₹30,00,000; Interest (r) = 10% p.a.; Period = 10 years

(i) To make annual payment into the fund at the end of each year
( 1+𝑟) 𝑛−1
Future Value = 𝑃𝑉 × [ ] or 𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 × 𝐹𝑉𝐼𝐹𝐴𝑟,𝑛
𝑟
₹30,00,000 = 𝐴𝑛𝑛𝑢𝑎𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 × 𝐹𝑉𝐼𝐹𝐴10%,10
30,00,000
Annual Payment = ≅ ₹1,88,241.20
15.937
(1 + 𝑟) 𝑛 − 1
𝐹𝑉𝐼𝐹𝐴𝑟,𝑛 (𝐹𝑢𝑡𝑢𝑟𝑒 𝑣𝑎𝑙𝑢𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑓𝑎𝑐𝑡𝑜𝑟 𝑓𝑜𝑟 𝑎𝑛𝑛𝑢𝑖𝑡𝑦) = [ ]
𝑟

(ii) To invest a lump sum amount in the fund at the end of the year
Future Value = 𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 × 𝐹𝑉𝐼𝐹10% ,9 or 𝐴𝑛𝑛𝑢𝑎𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 × (1 + 0.1) 9
₹30,00,000 = 𝐴𝑛𝑛𝑢𝑎𝑙 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 × 2.358
30,00,000
Annual payment = ≅ ₹12,72,265
2.358
𝐹𝑉𝐼𝐹𝑟,𝑛 (𝐹𝑢𝑡𝑢𝑟𝑒 𝑣𝑎𝑙𝑢𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑓𝑎𝑐𝑡𝑜𝑟) = (1 + 𝑟) 𝑛

(iii) To make annual payment into the fund in the beginning of each year
(1+𝑟) 𝑛−1
Future Value = 𝑃𝑉 × [ ] × (1 + 𝑟)
𝑟
or 𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑎𝑦𝑚𝑒𝑛𝑡 × 𝐹𝑉𝐼𝐹𝐴10%,10 × (1 + 𝑟)
30,00,000
Annual Payment = ≅ ₹1,71,125.20
15.937×1.10
(1 + 𝑟) 𝑛 − 1
𝐹𝑉𝐼𝐹𝐴𝑟,𝑛 (𝐹𝑢𝑡𝑢𝑟𝑒 𝑣𝑎𝑙𝑢𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑓𝑎𝑐𝑡𝑜𝑟 𝑓𝑜𝑟 𝑎𝑛𝑛𝑢𝑖𝑡𝑦) = [ ]
𝑟

Example 13 PERPETUITY
A company is selling a debenture which will provide annual interest payment of ₹1,200 for
indefinite number of years. Should the debenture be purchased if it is being quoted in the market
for ₹10,500 and the required rate of return is 12%? What will be your answer if the required rate of
return is 10%?
(B. Com. Honors, Delhi University)

Solution
𝐶𝐹1 𝑜𝑟 𝐴
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 (𝑃𝑉𝑝 ) =
𝑟
Where, 𝑃𝑉𝑝 = Present value of a perpetuity
r = Rate of interest
𝐶𝐹1 𝑜𝑟 𝐴= Single cash flow
If r is 12%
Chapter 2, Time Value of Money: 9
 1,200
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 (𝑃𝑉𝑝 ) = = ₹10,000
0.12
If r is 10%
1,200
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 (𝑃𝑉𝑝 ) = = ₹12,000
0.10
At present the debenture is quoted at ₹10,500. Hence,
i. if r is 12% debenture should not be purchased as the current market price of ₹10,500 is
more than current worth of ₹10,000.
ii. if r is 10% debenture should be purchased as the current market price of ₹10,500 is less
than current worth of ₹12,000.
Note:
The formula of the present value of the perpetuity has been used because the maturity period of the
debenture is not given (debentures are irredeemable).

Example 14
Vijay borrows from the Kings Bank an amount of ₹10,00,000 at 12% per annum on 01-04-2012. As
per the agreement, repayment including interest is to be made in five equal annual installments
with first installment falling due after three years, i.e., on 31-03-2015. What would be the amount of
each installment?
(B. Com. Honors, Delhi University)

Solution
Amount outstanding at the end of the 2nd year, i.e., one year before the first payment.
FV = 𝑃𝑉 (1 + 𝑟) 𝑛
= ₹10,00,000 × (1 + 0.12) 2
= ₹10,00,000 × 1.254
= ₹12,54,400
Now, the FV becomes the PV for 5 installments. Hence, yearly payment will be calculated as
follows—
1
1−
(1 + 𝑟) 𝑛
𝑃𝑉𝐴 = 𝐹𝑉 𝑜𝑟 𝐴 𝑜𝑟 𝐸𝑀𝐼 × [ ]
𝑟
1
1−
(1 + 0.12) 5
12,54,400 = 𝐹𝑉 𝑜𝑟 𝐴 𝑜𝑟 𝐸𝑀𝐼 × [ ]
0.12

12,54,400 = 𝐹𝑉 𝑜𝑟 𝐴 𝑜𝑟 𝐸𝑀𝐼 × 3.605

12,54,400
𝐹𝑉 𝑜𝑟 𝐴 𝑜𝑟 𝐸𝑀𝐼 =
3.605
𝐹𝑉 𝑜𝑟 𝐴 𝑜𝑟 𝐸𝑀𝐼 = ₹3,47,961

Example 15
Mr. Ajay won a prize in a game show. He is provided with the following three alternatives of
receiving his prize—
i. ₹1,10,000 right now.
ii. An annuity of ₹15,000 at the end of each year for 10 years.
iii. A perpetuity of ₹10,000 forever.
Which of the alternatives is most suitable for Mr. Ajay if he has opportunity to earn 10% per
annum?
(B. Com. Honors, Delhi University, 2011)

Solution
In this question we can compare the future values of all the amounts, but it is not possible, as in the
option I and option III, time period is not given. So, we can compare the present value of the
amounts in all the options.
Chapter 2, Time Value of Money: 10
Option I
The present value is already given in the statement which is ₹1,10,000.

Option II
1
1−
(1 + 𝑟) 𝑛
𝑃𝑉𝐴 = 𝐹𝑉 𝑜𝑟 𝐴 × [ ]
𝑟
1
1−
(1 + 0.10) 10
𝑃𝑉𝐴 = 15,000 × [ ]
0.10

𝑃𝑉𝐴 = 15,000 × 6.145

𝑃𝑉𝐴 = ₹92,175

Option III
10,000
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 (𝑃𝑉𝑝 ) = = ₹1,00,000
0.10
Which of the alternatives is most suitable for Mr. Ajay?
Option I Option II Option III
Present value ₹1,10,000 ₹92,175 ₹1,00,000
Rank First Third Second
The present value is maximum under option I so, he should receive ₹1,10,000 right now.

Example 16
Mr. Sampat wants to go on a world tour after 10 years. This tour is expected to cost him ₹7,00,000.
How much should he save annually to have a sum of ₹7,00,000 after 10 years if rate of interest is (i)
10% and (ii) 12%.
(B. Com. Honors, Delhi University, 2012)

Solution
(i) If the rate of interest is 10%
(1 + 𝑟) 𝑛 − 1
𝐹𝑉𝐴 = 𝑃𝑉 × [ ]
𝑟
(1 + 0.10) 10 − 1
7,00,000 = 𝑃𝑉 × [ ]
0.10
7,00,000 = 𝑃𝑉 × 15.937
7,00,000
𝑃𝑉 =
15.937
𝑃𝑉 = ₹43,923
So, Mr. Sampat should invest ₹43,923 annually.

(ii) If the rate of interest is 12%

(1 + 𝑟) 𝑛 − 1
𝐹𝑉𝐴 = 𝑃𝑉 × [ ]
𝑟
(1 + 0.12) 10 − 1
7,00,000 = 𝑃𝑉 × [ ]
0.12
7,00,000 = 𝑃𝑉 × 17.549
7,00,000
𝑃𝑉 =
17.549
𝑃𝑉 = ₹39,888
So, Mr. Sampat should invest ₹39,888 annually.

Chapter 2, Time Value of Money: 11

Example 17
Mr. Gautam is borrowing ₹20,00,000 from a bank for expanding his business. Bank is giving him
two options. Option one is to return this money in five equal annual installments at rate of interest
of 10% per annum. Option two is to return this money in equal half-yearly installments over a
period of five years at annual rate of interest of 9.8%. Which option should he select and why? Show
the working.
(B. Com. Honors, Delhi University, 2013)

Solution
Present value = ₹20,00,000
r = 0.10 or 0.098
time = 5 years (equal annual installment or half yearly installment)
Interest rate under Option 1 0.10
𝑟 𝑚 0.098 2
Effective Interest rate under Option 2 𝑟𝑒 = [1 + ] − 1 ⇒ [1 + ] = 0.100401
𝑚 2
Under first option the effective interest is less, so, Mr.
Decision
Gautam should select the option 1.

Example 18
Mr. X wants ₹5,00,000 at the end of 8 years from now. Find the amount to be deposited each year in
an account offering 10% interest compounded per annum.
(B. Com. Honors, Delhi University, 2015)

Solution:
(1 + 𝑟) 𝑛 − 1
𝐹𝑉𝐴 = 𝑃𝑉 × [ ]
𝑟
(1 + 0.10) 8 − 1
5,00,000 = 𝑃𝑉 × [ ]
0.10
5,00,000 = 𝑃𝑉 × 11.436
5,00,000
𝑃𝑉 =
11.436
𝑃𝑉 = ₹43,721.58
Mr. X should deposit ₹43,721.58 annually to get ₹5,00,000 at the end of 8th year.

Example 19
Explain whether ₹1,00,000 received today is better than ₹1,25,000 to be received 3 years from
today? (Make your assumption while explaining this)
(B. Com. Honors, Delhi University, 2022) [Open Book Examination]

Solution
Whether ₹1,00,000 received today is better than ₹1,25,000 to be receive 3 years from today, this
can be decided on the basis of rate of return (discount rate). Different rates can lead to different
results. Let us understand this with the help of an example under different assumptions of discount
rates—
Discount Rate 10% 9% 8% 7% 6% 5%
Present value of 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000
₹10,00,000 received
today
Present value of 93,914.35 96,522.94 99,229.03 1,02,037.23 1,04,952.41 1,07,979.70
₹1,00,000 received 3
years from today
VERIFICATION: Future 1,25,000 1,25,000 1,25,000 1,25,000 1,25,000 1,25,000
value of present value of
₹1,25,000 to be received
3 years from now
Chapter 2, Time Value of Money: 12
 Whether ₹1,00,000 Money Money Money Money Money Money
received today is better received received received received received received
than ₹1,25,000 to be today is today is today is today is not today is not today is not
received 3 years from better as its better as its better as its better as its better as its better as its
today PV is more PV is more PV is more PV is more PV is more PV is more
than the PV than the PV than the PV than the PV than the PV than the PV
of future of future of future of future of future of future
sum sum sum sum sum sum
Conclusion: In the above example, given the fact that time is 3 years, then money received today is
better than future sum till the rate of return (discount rate) is more than 7%. In case the rate
of return (discount rate) is equal to 7% or less then money received today is not better than
future sum
Notes:
𝐹𝑉
1. Formula for calculating present value of a single future cash flow: 𝑃𝑉 = 𝑛 (1+𝑟)
2. Formula for calculating future value of a single present cash flow: 𝐹𝑉 = 𝑃𝑉(1 + 𝑟) 𝑛

Chapter 2, Time Value of Money: 13

Annexure [Not in syllabus]
Fixed/Flat-rate method and reducing-balance method of calculating
EMI
EMI is the equated monthly installment. Whenever s person avails the facility of a loan, he/she is
supposed to repay principal and interest thereon in equal monthly installments. It is calculated
using either fixed/flat-rate method or reducing-balance method.

Formula under fixed/flat-rate method is—

𝑃 + (𝑃 × 𝑟 × 𝑛)
𝐸𝑞𝑢𝑎𝑡𝑒 𝑚𝑜𝑛𝑡ℎ𝑙𝑦 𝑖𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡(𝐸𝑀𝐼) =
𝑛 × 12
Where,
𝑃 = Principal amount
𝑟 = Rate of interest
𝑛 = Number of years
Under the flat rate method, the total principal and total interest payable for the time for which the
loan facility has been availed is divided by the total number of installments. Total number of
installments can be calculated by multiplying the number of years by 12.

Formula under reducing balance method is—

(𝑃 × 𝑟) × (1 + 𝑟) 𝑛
𝐸𝑞𝑢𝑎𝑡𝑒 𝑚𝑜𝑛𝑡ℎ𝑙𝑦 𝑖𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡(𝐸𝑀𝐼) =
(1 + 𝑟) 𝑛 − 1
Where,
𝑃 = Principal amount
𝑟 = Monthly rate of interest i.e. Interest rate/12
𝑛 = Number of years
Under the reducing balance method, the interest is charged on the balance of principal amount. The
EMI is calculated in such a way that it includes principal and interest and with each EMI the
proportion of principal increases and the proportion of interest decreases. From the customer’s
view point this method is useful as he/she ends up paying lesser amount as compared to the flat
rate method.

Derivation of formula under reducing balance method

Let us assume that—
𝑃0 = Principal amount of loan
𝑃1 , 𝑃2 , 𝑃3 , ⋯ ⋯ ⋯ , 𝑃𝑛 = Balance principal at the end of 1𝑠𝑡 , 2𝑛𝑑 , 3𝑟𝑑 , and 𝑛𝑡ℎ month
𝑟 = Monthly interest rate
Monthly interest rate = 𝑃 × 𝑟
𝐸 = Equated Monthly Installment
Now balance at the end of 1𝑠𝑡 month,
𝑃1 = 𝑃 + 𝑟 × 𝑃 − 𝐸
𝑃1 = 𝑃 × (1 + 𝑟) − 𝐸
𝑃2 = 𝑃1 × (1 + 𝑟) − 𝐸
Substituting the value of 𝑃1 in the equation,
𝑃2 = (𝑃 × (1 + 𝑟) − 𝐸 ) × (1 + 𝑟) − 𝐸
Expanding the equation, we get,
𝑃2 = 𝑃 × (1 + 𝑟) 2 − 𝐸 × ((1 + 𝑟) + 1)
Substituting (1 + 𝑟) by 𝑡 we get,
𝑃2 = 𝑃 × 𝑡 2 − 𝐸 × (𝑡 + 1)
Continuing the equation and calculating 𝑃3 , 𝑃4 , 𝑃5 and so on,
𝑃𝑖 = 𝑃 × 𝑡 𝑖 − 𝐸(1 + 𝑡 + 𝑡 2 + ⋯ ⋯ ⋯ + 𝑡 𝑖−1 )
At the end of last month of the tenure of the loan 𝑃𝑛 would be,
𝑃𝑛 = 𝑃 × 𝑡 𝑛 − 𝐸 × (1 + 𝑡 + 𝑡 2 + ⋯ ⋯ ⋯ + 𝑡 𝑛−1 ) = 0
The above equation means,

Chapter 2, Time Value of Money: 14

 𝑃 × 𝑡 𝑛 = 𝐸 × (1 + 𝑡 + 𝑡 2 + ⋯ ⋯ ⋯ + 𝑡 𝑛−1 )
The sum of geometric series is given by,
(𝑡 𝑛 − 1)
(𝑡 − 1)
Let us substitute the sum of a geometric series in the equation,
(𝑡 𝑛 − 1)
𝑃 × 𝑡𝑛 = 𝐸 ×
(𝑡 − 1)
The equation can be rewritten as,
(𝑡 − 1)
𝐸 = 𝑃 × 𝑡𝑛 × 𝑛
(𝑡 − 1)
Let us substitute the value of 𝑡 by (1 + 𝑟),
((1 + 𝑟) − 1)
𝐸 = 𝑃 × (1 + 𝑟) 𝑛 ×
((1 + 𝑟) 𝑛 − 1)
(1 + 𝑟) 𝑛
𝐸 = 𝑃 ×𝑟 ×
((1 + 𝑟) 𝑛 − 1)
(𝑃 × 𝑟) × (1 + 𝑟) 𝑛
𝐸=
((1 + 𝑟) 𝑛 − 1)
(𝑃 × 𝑟) × (1 + 𝑟) 𝑛
𝐸= ∎
(1 + 𝑟) 𝑛 − 1

Example
What do you understand by EMI? How is it calculated? If we assume that an investor takes a loan of
₹5,00,000 (5 lakh) which is the principal loan amount, at an interest rate of 9.50% for 10 years. The
investor’s EMI using the flat-rate method is calculated to be ₹8,125 only and the total payments
equal to ₹9,75,000. Now assume that the EMI reducing-balance method was used instead of EMI
fixed-rate method, using the EMI reducing-balance method EMI is ₹6,470 only and the total payments
equal to ₹7,76,000. Interpret the two methods based on the information based on the information
provided.
EMI using flat rate method—
𝑃 + (𝑃 × 𝑟 × 𝑛)
𝐸𝑞𝑢𝑎𝑡𝑒 𝑚𝑜𝑛𝑡ℎ𝑙𝑦 𝑖𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡(𝐸𝑀𝐼) =
𝑛 × 12
₹5,00,000 + (₹5,00,000 × 0.095 × 12)
= ≅ ₹6,470
10 × 12
EMI using reducing balance method—
(𝑃 × 𝑟) × (1 + 𝑟) 𝑛
𝐸𝑞𝑢𝑎𝑡𝑒 𝑚𝑜𝑛𝑡ℎ𝑙𝑦 𝑖𝑛𝑠𝑡𝑎𝑙𝑙𝑚𝑒𝑛𝑡(𝐸𝑀𝐼) =
(1 + 𝑟) 𝑛 − 1
0.095 0.095 10×12
(₹5,00,000 × ) + (1 + )
⇒ 12 12
0.095 10×12
(1 + ) −1
12
(₹5,00,000 × 0.007916̅) + (1 + 0.007916̅) 120 ₹10,196.88592
⇒ ⇒
(1 + 0.007916̅) − 1
120 1.57605539346
⇒ ₹6469.8 ≅ ₹6,470

Chapter 2, Time Value of Money: 15