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Time Value of Money

The document discusses key concepts related to time value of money including nominal and effective interest rates, compounding, present and future value calculations, annuities, perpetuities, and cash flow modeling and discounting. It provides examples of how to use the PV, FV, NPV and other Excel functions to solve time value of money problems and calculate values like internal rate of return. The document also covers topics like compounding frequency, rule of 72, annuity formulas, growing perpetuities, and multi-period cash flows.

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Abhinav Rajverma
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0% found this document useful (0 votes)
49 views25 pages

Time Value of Money

The document discusses key concepts related to time value of money including nominal and effective interest rates, compounding, present and future value calculations, annuities, perpetuities, and cash flow modeling and discounting. It provides examples of how to use the PV, FV, NPV and other Excel functions to solve time value of money problems and calculate values like internal rate of return. The document also covers topics like compounding frequency, rule of 72, annuity formulas, growing perpetuities, and multi-period cash flows.

Uploaded by

Abhinav Rajverma
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Time Value of Money

Abhinav Rajverma
Contact: +91-81281-95751
Time Value of Money
A rupee today is worth more than a rupee in the future.
Basic Concepts
• Timelines & CFs
• Nominal/Effective/Periodic Rates
• Compounding
• PV/FV of lumpsum
• PVF & FVF
• Annuities/Perpetuities
• Growing Perpetuity

Excel Functions
2
Excel Functions

PV Function
Syntax = PV (rate, nper, pmt, [fv], [type])

FV Function
Syntax = FV (rate, nper, pmt, [pv], [type])

NPV Function
Syntax = NPV (rate, value1, value2…..)

PMT Function
Syntax = PMT (rate, nper, pv, [fv], [type])

3
Modeling for Time and Risk

CFs Modeling
• Even Timeline
• Uneven
Time-difference between CFs
• Even
Timeline
• Uneven
Modeling for “r”
• Constant per period Equivalent Rate
• Not Constant - Bootstrapping

4
Timeline

T0 T1 T2 T3
r = i%
CF0 CF1 CF2 CF3

 Timeline takes care of CFs


 Timeline takes care of time-differences

“Modeling for risk (r)”: Find equivalent rate (r) for one period
Note: Time period may be of any time duration
Always draw a timeline to visualize the timing of CFs

5
What is a rate (r) ?

What is rate (TVM)


 Returns on investments
Interest Rate
Bond Yield
Dividend Yield
Capital Gain Yield
 Discount Rate (costs)
Cost of Equity
Cost of Debt
WACC

6
Present Value (PV)
What is ? How is value determined?
Subjective
Objective
Valuation (or CFs)
1. No Uncertainty – Complete Solution
2. Uncertainty – Partial Solution (approximation)
The Value is determined the same way, but how?

INR 2000 + USD 50 = ??


 Can we add ??: first convert into a common currency
 Same principle for CFs with different dates
 CFs can be converted to PV

7
Net Present Value (NPV)
Net of initial cost of investment
Captured by date 0 cashflow
PV (of future CFs) minus initial investment
Cashflows (CFs)
 CFs can be positive or negative

Illustration: Assume, you invest ₹1000 today that earns CFs


of ₹500 and ₹700 in year 1 and year 2, respectively. What is
the net value of the project today?

Discount Rate?

8
NPV Example
IRMA pays an annual electricity bill of ₹10,00,000. ABC
Calibrations offers to install a circuit system for ₹2,50,000 that
will reduce bills by ₹1,00,000 per annum for the next three years.
Is this a good investment? Assume the interest rate is 10%.

Year 0 1 2 3
CFs -250,000 100,000 100,000 100,000

PVF 1 1/(1.1)^1 1/(1.1)^2 1/(1.1)^3


CFs -250,000 90,909 82,645 75,131

₹ (-) 1,315

9
Equivalent Periodic Rate Calculation

FV at time T is same (equal)


=

Þ=
Þ=

Þ=

m & n are number of period(s) per year


 & are effective periodic rates

10
Power of Compounding
𝐴 𝑇 = 𝐴 0 (1+ 𝑅/ 𝑚)𝑚𝑇
Compounding Value of 100
frequency (in 1 year at 10% nominal)
Annual (m=1) 110.000
Semi-annual (m=2) 110.250
Quarterly (m=4) 110.381
Monthly (m=12) 110.471
Weekly (m=52) 110.506
Daily (m=365) 110.516

Continuous Compounding ??
FV of a lumpsum

FVF =
PVF = 1/FVF =

Example: Assume, you invest ₹1000 today that earns a return of


10 percent, compounded annually. How much will you receive
after year 1, year 2, and year 3?

Year Beginning Yearly Total Ending Direct Method


Amount Interest Interest Amount
1 1,000 100 100 1,100 1,000 * (1+0.1)1
2 1,100 110 210 1,210 1,000 * (1+0.1)2
3 1,210 121 331 1,331 1,000 * (1+0.1)3

12
Doubling Period
Rule of 72:
Doubling period = 72/Interest Rate
Rule of 69:
Doubling period = 0.35 + 69/Interest Rate

Example: Assuming interest rate of 9%, calculate the


doubling period.

Rule of 72: Doubling period = 72/9 = 8.00 years


Rule of 69: Doubling period = 0.35 + 69/9 = 8.02 years

* Rule of 69 offers more accurate result.


13
Excel Function: PV and FV

PV Excel Function
Syntax = PV (rate, nper, pmt, [fv], [type])
Example 1: You have an option of selecting either of the three
income. (1) ₹1000 after 2 years (2) ₹1080 after 3 years, and (3)
₹1200 after 5 years. Assuming a return of 10 percent,
compounded annually. What will be your selection?

FV Excel Function
Syntax = FV (rate, nper, pmt, [pv], [type])
Example 2: Assume, you invest ₹1000 today that earns a return
of 10 percent, compounded annually. How much worth is your
investment after year 2, year 3, and year 5?

14
Annuity
An annuity is a series of identical payments at equal intervals.

Ordinary Annuity
0 1 2 3
i%

1000=PMT 1000 1000


Annuity Due
0 1 2 3
i%

1000=PMT 1000 1000

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Annuity Formula
An annuity is a series of identical payments at equal intervals.

+ + ……. +

+ …….

𝐶
𝑟 ∗ 𝑃𝑉 = 𝐶 − 𝑇
(1 +𝑟 )

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Example: Ordinary Annuity (1/2)
Problem: Find the PV of a 3-year ordinary annuity of Rs.
1000 at 10%?

0 1 2 3
10%

1000 1000 1000


909.1
826.4
751.3
2486.9 = PV

17
Example: Ordinary Annuity (2/2)
Problem: Find the PV of a 3-year ordinary annuity of Rs.
1000 at 10%?
Using Annuity Formula:

= 2486.9

Using Excel Function:


Syntax = PV (rate, nper, pmt, [fv], [type])
PV = 2486.9

18
FV of Ordinary Annuity (1/2)
Problem: Find the FV of a 3-year ordinary annuity of Rs.
1000 at 10%?

0 1 2 3
10%

1000 1000 1000


1100
1210
FV = 3310

19
FV of Ordinary Annuity (2/2)

Q. Find the FV of a 3-year ordinary annuity of Rs. 1000 at 10%?

Using Annuity Formula:


FV = 1000 * = 3310
Using Excel Function:
FV = FV (rate, nper, pmt, [pv], [type]) = 3310

20
Perpetuity
A perpetuity is a series of identical CFs forever at equal intervals.

+ + …….

+ …….

𝑟 ∗ 𝑃𝑉 =𝐶
𝑷𝑽 =𝑪 /𝒓
*Dividend Discount Model (DDM) uses the concept of a perpetuity

Growing Perpetuity ??
21
Uneven CFs
Q. Find PV of the CFs assuming expected return of 10% per period.

0 1 2 3
10%

-50 100 75 50

Solution:
• Get PV of all the CFs
• Add all the PVs to get NPV of the CFs

22
Retirement problem
Scenario Solution
1. Retirement in 35 years
2. Deposit Rs. 25,000 every year 1. Time Period = 35 yrs
into an Index fund
2. PMT = Rs. 25,000
3. Returns expected = 12.1%
annually
3. Interest Rate = 12.1%
4. How much will you have on
retirement after 35 years?
4. FV = ? = Rs. 1,10,48,533
5. How much total cash will you
have to outlay to accumulate 5. Total cash outlay = 25,000 *
that much? 35 = Rs. 8,75,000
6. Calculate the lumpsum fund 6. Lump sum fund (PV) =
required to generate same FV*PVF = 1,10,48,533*
amount in 35 years. 0.018357 = Rs. 2,02,819
Takeaways

Time Value of Money


Time and Money
Excel Functions: PV, FV, PMT, RATE, etc.
Annuity Concepts
Perpetuity Concepts
Retirement Planning

24
Thank You
for
Your Time

25

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