Subject: Financial Management

Chapter: Two – Time Value of Money

Chapter No. 2 - Time Value of Money

Contents
♦ Introduction to the concept of “inflation” – Wholesale Price Index and
Consumer Price Index
♦ Money losing value due to reduction in purchasing power
♦ Concept of interest as compensation in purchasing power of money
♦ Four tier structure for rates of interest in any economy
♦ Compounding and discounting processes
♦ Application of time value of money to business decisions
♦ Numerical exercises for practice

At the end of the chapter the student will be able to

♦ Determine - Future value of a present sum by compounding
♦ Determine - Present value of a future sum by discounting
♦ Determine - Present value of a bond investment
♦ Explain - the different tiers of interest structure in an economy
♦ Choose – the best project based on its “Net Present Value”

Concept of “Inflation” – Wholesale Price Index and Consumer Price Index

Inflation means to increase. In this context, it means increase in prices of commodities. The price
increase is due to the difference between “supply” and “demand” for a given commodity. If the supply
is more than demand, prices decline and if the demand is more, prices increase. In a developing
country like India, the demand for most of the commodities will always be more than the supply.
Hence “inflation” will always be experienced in developing markets.
The increase is constantly measured in all the countries. The items included for determining the prices
would be different from country to country. For example, in India, essential commodities like sugar,
kerosene, a loaf of bread etc. are included in the basket of commodities considered for calculation of
“inflation”. Different from this, in a developed country, items that are luxury items in a developing
country would also be included. For example, automobile could be included. The increase is expressed
in % terms. For example if the rate of inflation is 5%, this means that over a period of one year, the
prices have increased by 5%. The details of inflation are published regularly in all leading dailies in the
country.

Wholesale price and not the retail price

The prices of the selected commodities for determining the rate of inflation over a period of one year
could be on the wholesale or retail. The latter one is mostly referred to as “consumer price”. Thus we
have a “wholesale price index” and “consumer price index” for expressing rates of inflation.
Conventionally in India the rate of inflation has always been expressed in “wholesale price index” basis

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rather than “consumer price index” basis although the consumer price index increase is also published
regularly. At present the wholesale price index inflation is around 3%. We will explain this concept
through an example.
Example no. 1
I had spent Rs. 100/- in getting a basket of commodities one year ago. If the rate of inflation is say 3%,
now I will be required to spend Rs. 103/- to get the same basket of commodities. How do we get
Rs.103/-? Rs. 100/- x 1.03 = Rs. 103/-. This means that due to “inflation”, the purchasing power of the
local currency decreases with the passage of time. This is exactly the concept of “time value of
money”. In simple words, “time value of money” means that with the passage of time, money loses its
value.

Is there a situation in which the prices decrease over a period of time and
opposite of “inflation” takes place?
Usually in a developing country, such a situation does not arise, as the demand is always greater than
supply. However currently Japan is experiencing “deflation” in which current prices would be less than
the past prices. This is harmful to a developing economy, as units that save money would get very low
interest or no interest. Hence there will be no incentive for the units to invest money in bonds, fixed
deposits etc.

Concept of Interest as compensation for loss of purchasing power due to

“inflation”:
You keep money in a deposit with a bank. It could be a Savings Bank or a Fixed Deposit. What does the
bank pay to you? “Interest”. This is the “return” on your investment. Why should the bank pay interest
to you? Let us enumerate the possible reasons for the bank’s action.
♦ The bank does the business of lending. For this, it requires funds through deposits. It earns
interest on loans and pays interest on deposits;
♦ With the passage of time, the purchasing power of money reduces. The same thing will happen
to your deposit with the bank. The bank gives compensation to you for this loss in value of
money;
♦ In case the bank does not pay interest, it will not get funds for lending. You will not keep
deposits with it. You will choose other willing banks or avenues of investment.
While all of them are correct, we are more interested in the second reason. Value of money erodes due
to “inflation” as we have seen in the earlier paragraph. The rates of inflation would be different for
different countries. Further, it could be different for the same country at different times. Sometimes it
could be high while at some other times, it could be low.
Note:1
Would interest be less in case the rate of inflation comes down?
Absolutely. As an example, we have already seen what is happening in Japan. The Japanese banks are
practically not paying interest on deposits right now. The rate of inflation in the US is around 2% p.a.
and accordingly the rate of interest on investment would be around 3% to 3.5% p.a. Thus the rate of
inflation in a country and the rate of interest on investment are closely linked to each other. For further
details, please look at the “Tier structure” of rates of interest given below.
Consider Indian market conditions. Hypothetically if the inflation comes down to say 1%, the rat e of
interest on bank deposits and bank loans in turn would also come down. The banks would not pay the
current rate of interest. If the students may recall in India, the rates of interest on savings are
constantly coming down. This is the result of the rate of inflation coming down constantly at least till
the last year.

1
“Rate of inflation coming down” - What does it mean? Does it mean that the prices of commodities are coming
down or the increase in prices of commodities is coming down? – Answer is: The increase in prices of commodities
is coming down; in actual terms, the prices of commodities are not reducing.

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Four tier structure for rates of interest in any economy

The starting point for any interest is the rate of inflation in the economy. Like for example, in India at
present, it is around 3% now. We have seen earlier that interest is the compensation for loss of
purchasing power of Indian Rupee. This loss is due to the phenomenon of “inflation”. We have also
learnt that the banks would normally offer a rate of interest higher than the rate of inflation. Based on
this, let us construct a 4-tier system of interest rates. This would build up stage-wise rates of interest
till investment in a project.
Tier 1 – Rate of inflation, say 3%
Tier 2 – Rate of interest on investment say in bank deposit
Rate of inflation + some compensation from the acceptor of deposits, say banks. = 3% + 4% = 7%,
that is the lowest interest offered by a public sector bank now on fixed deposits. The exact premium
paid to the depositor depends on the following:
♦ The duration of the deposit – the longer the duration, the higher the premium and vice-versa.
That is why the longer duration deposits would attract higher rates of interest and shorter
duration deposits would have a lower rate of interest.
♦ The need for deposits by the banking company for a specific period. The bank would offer a
higher rate for that period. Suppose a bank wants more deposits for six months rather than
one year. It will attract deposits for six months by offering higher rate of interest than the
market.
Tier 3 – What does the bank do with the deposits that it accepts? It gives loans. The rate of interest on
loans becomes the next tier, Tier 3.

What are the factors that a bank would consider to determine its lending rate?
Average interest paid out on deposits and expenses
Minimum expected profit from lending operations
Degree of risk in lending – specific to a borrower, depending upon his business
Continuing discussion on Tier 3, we see that the minimum rate of interest on loans would be 7% + 3%
+ 1% = 11%. This is the lowest interest that any bank offers now in India on loans. There is a specific
name for this rate. It is referred to as “Prime Lending Rate” or PLR. The bank would add further to this
rate depending upon risk etc., which is called “risk premium”2. This would again be different from
borrower to borrower.

Why discuss about a loan here?

Who takes loans in a big way from the banks? This does not refer to the housing or consumer loans
taken by salaried persons. Obviously, business enterprises. It is for investment in their
business/projects. Hence the rate of return on a project would be the last Tier, called “Tier 4”.
Can you determine this rate? Yes and no. Yes, as you will be able to determine a formula for this. No,
because, it is not always possible to evaluate risk associated with a project correctly.
The formula is:
Rate of interest on loans, say 11% + compensation for the additional risk taken by the project owner.
For an outsider, it will not be possible to put a figure on this. This will depend upon the risk associated
with the specific project.

2
This is the reason that for different activities, the same bank charges different rates of interest at the
same time. Similarly for different borrowers pursuing the same activity, the rates of interest would be
different as per perception of risk associated with them.

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From whose point of view? - Both from the points of view of the owner and the lender/investor. This
compensation is referred to as “risk premium” of the project.
The question that could come to one’s mind while reading these lines is:
Why should a project owner expect a higher rate of return than the rate of interest on loans?
Consider the following and learn the risk associated with a project.
♦ The project owner’s investment does not have the backing of assets. A lender, on the contrary,
has backing of assets for his loan.
♦ The enterprise pays the lender interest periodically. The owners on the contrary, get return in
the form of dividend. This is not certain.
♦ Besides interest, the enterprise should also have sufficient surplus after paying interest to
repay the loan amount
♦ Risk of project failure affects the owners more than the lenders for the same reason as
mentioned in the first bullet point

Example No. 2
Let us summarise the above as under:
Rate of inflation = Tier no. 1 = 3% p.a.
Rate of interest on investment = Tier no. 2 = 7% p.a.
Rate of interest on loans = Tier no. 3 = 11% p.a.
Rate of return from investment in projects = Tier no. 4 = 15% p.a. (This is just an example. The rate of
return expected from a project would actually depend upon the degree of risk associated with the
project in the perception of the project owners primarily and project lenders secondarily)

Future value of Re.1 - Process of compounding

Refer to Example no. 1. We found out that we would require Rs.103/- to purchase a basket of
commodities that we could purchase at Rs.100/- a year ago and the rate of inflation works out to 3%
p.a. Can we give another name for the value after one year? Yes. It is called the “future value”, while
Rs.100/- is called the present value. The other name for the future value is “compounded value” as
this is obtained by a process called “compounding”.

Can we have a formula for this process of compounding?

n
Future value (F.V.) at T1 = PV at T0 x (1+r/100) , wherein T1 is the end of year 1 and T 0 is the
beginning of year 1.
n
(1 + r/100) is known as compounding factor.

Let us apply this formula to another investment example and determine the future value.

Example no. 3
You have a fixed deposit for Rs.10,000/- in a bank. Terms of deposit are:
Period – Two years
Rate of interest = 10% p.a.
The bank does not pay interest periodically. Interest gets accumulated to the principal amount; it gets
paid at the end of the period along with principal amount.

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What is the future value of this investment?

The future value is Rs.12,100/-. In the compounding formula, by substituting 10% for “r” and 2 for “n”,
we get this value. The break-up of principal and interest amount for the period of investment, i.e., two
years is as under:
Principal – Rs.10,000/-
Interest – Rs.2,100/-

Does the future value alter with the change in the frequency of compounding?
In the above example, we have assumed that the bank pays interest at the frequency of one year.
Suppose the bank pays interest at a higher frequency, would the future value turn out to be different?
Let us see the following example.

Example no. 4
Suppose the bank increases the frequency of compounding from yearly to half-yearly. What will be the
future value? We can use the same formula with an amendment. The amended formula would be:
nx2
Future value = Present investment x (1 + r/200)
As interest gets compounded twice as frequently, r is divided by 200. Similarly the number of periods
for compounding also gets doubled and hence it is 2 x n instead of “n”. Accordingly, in our formula,
what would be the values of “r” and “n”?
r = 5% and n = 4
4
With these values, the future value FV at T2 works out to 10,000 x (1.05) = Rs.12,155/-.
Similarly we can see that in case the frequency of compounding increases to quarterly from half-
yearly, the future value works out to Rs. 12,184/-.

Let us summarise what we have learnt so far on “compounding and future value”:
♦ The amount that you get back at the end is called “future value”
♦ Future value is determined by “compounding”
♦ Future value depends upon:
♦ Rate of interest and
♦ Frequency of compounding
♦ The multiplying factor is known as “compounding factor”
♦ The more the frequency, the higher the amount of interest

Doubling period
A frequent question posed by an investor is: “How much time it will take for my investment to double
in value”? This question can be answered by a rule known as “Rule of 72”. It is an approximate way of
finding out the doubling period. Suppose the rate of interest is 12%. The doubling period is 6 years.
A more accurate answer can be had by a better formula like:
0.35 + 69/interest rate in % terms. Employing the same rate of 12%, we find that the doubling period
is 6.10 years instead of 6 years. This is more accurate than the Rule of 72 formula.

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Present value of a future rupee – Process of discounting

So far we have seen “future value”. We are now going to see “present value” of a future sum. Suppose
we want to have Rs.10,000/- after say two years (T2). We want to know how much we should save now
(T0). This situation is exactly the opposite of the earlier future value situation. The investment at T0
should increase to the desired future value at a desired rate of interest. The process of determining
the present value from future value is known as “discounting”. “Discounting” is converse of
“compounding”.

Example no. 5

We want to get Rs.108/- at the end of T1. The desired rate of interest is 8% per annum. What is the
amount that we should invest at T0?
Can we use the “future value” formula here?
Yes – with necessary modification as under:
n
Future value = Present investment x (1 + r/100)

Future value at T1, Rs.108/- = PV at T0 (to be determined) x (1.08)

PV at T0 = Rs. 108/1.08 = Rs.100/-.

Thus the formula for present value is as under:

n
Present value = Future value = Future value x [1/(1 + r/100) ]

--------------------
n
(1 + r/100)

The reciprocal of compounding factor is referred to as “discounting factor. We need to multiply the
n
future value by this discounting factor and not divide. In the above formula, 1/(1+r/100) is referred
to as “discounting factor”.

Discounting factor = 1/compounding factor; discounting factor x compounding factor = 1.

Discounting factor would always be less than 1.

Example no. 6
We want to get Rs.10,000/- after two years. The desired rate of interest is 12% p.a. The frequency of is
yearly.
What is the present value of this future sum of Rs.10,000/-?
Present value = Rs. 7,971/-
The two-step process in determining present value is:

Step 1 = determine the discounting factor = 1/[1 + 12/200] 4 = 0.7924

Step 2 = multiply the future value by this factor to get the present value
Present value of Rs.10,000/- = Rs.7,924/-

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We have already seen under “future value” that higher frequency of compounding increases the future
value. Conversely, higher frequency of discounting decreases the present value. The students are
advised to take the following exercise and verify for themselves.

Exercise No. 1
After three years we are likely to get a windfall of Rs.1,00,000/-. What will be the present value of this
windfall, in case the expected rate of return is 15% p.a.?
Answer – Rs.65,751/-
Let us summarise what you have learnt so far on “discounting and present value”:
♦ Discounting is the converse of compounding
♦ It is used when you want to determine the present value of a future sum
♦ Just as there is a compounding factor, there is a discounting factor
♦ In case you determine the discounting factor, you should multiply the future value by this
factor to get the present value
♦ The more the frequency the of discounting, the less will be the value of present value
♦ Present value will always be less than future value by the same token of inflation.

Application of concepts of future value and present value in business

Where does one apply the future value and present value in business?
As discussed earlier, future value is helpful in determining the compounded return of an investment
and hence is more useful in the case of personal investment.
However, in the case of discounted value, the relevance is more to business. The following example
illustrates this.

Example no. 6 - Application 1

We want to start an Industrial project at T0 with an investment of Rs.100 lacs.

We expect to get a return of 20% from the project.
The estimated future earnings are:

T1 – Rs.30 lacs

T2 – Rs.35 lacs

T3 – Rs.40 lacs

T4 – Rs.45 lacs

We want to evaluate our investment decision in the project. How do we do this? By applying
discounting factor for 20% to the future earnings.

Present value of T1 = Value at T0 = Rs. 30lacs/1.20 = Rs.25 lacs

Present value of T2 = Value at T0 = Rs.35 lacs/(1.20)2 = Rs.24.30 lacs

Present value of T3 = Value at T0 = Rs.40 lacs/(1.20)3 = Rs.23.14 lacs

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And Present value of T4 = Value atT0 = Rs.45 lacs/(1.20)4 = Rs.21.69 lacs

The “sum total” of all the T0 values = Rs.94.13 lacs = Present value of future earnings for a period of
four years.
What does this mean? It means that at 20% expected return the project has given back only Rs.94.13
lacs. This is against Rs.100 lacs that have been invested in it. That is, the present value of future
earnings is less than original investment. Hence we will not invest in the project. The difference
between the present value of future earnings and the investment at T 0 is called the “Net present
value” or NPV. This is one of the fundamental methods of selecting a project.

Here is how we can use it for selecting a project:

♦ Determine the amount we need to invest in a project.
♦ Estimate future earnings from the project on certain working assumptions.
♦ Discount the future earnings by a suitable rate of discount. This depends upon the market rate
for borrowing and our perception of risk in the project. This gives the present value of all future
earnings.
♦ Compare this with the present value of investment. We invest in the project if the present
value of the future earnings is more than present value of investment.
♦ In the above example, suppose the present value is greater than Rs.100 lacs. Then we would
select the project for investment.

Exercise No. 2
We are investing in a project Rs. 1000 lacs. The rate of return that we expect from the project is 18%
p.a. The estimated future earnings for three years are:

T1 = Rs.450 lacs

T2 = Rs.500 lacs

T3 = Rs.550 lacs
The above are also referred to as cash flows 3(in this case cash inflows)
Examine as to whether it is worthwhile investing in the project. Find out the Net Present Value of the
project.

Answer:
Present value of future earnings = Rs.1071 lacs
Net Present Value = Rs.71 lacs
We can invest in the project

Example No. 7 - Application 2

Suppose there is a bond that has been floated in the market with face value of Rs.1000/-. The interest
per year is Rs.100/-. The period is 5 years. The expected rate of return is 8% p.a. What is the price at
which an investor will be willing to purchase the bond from the market now?

3
Cash flow could either be cash inflow or cash outflow. When an investment is made at T0 it is called “cash out
flow”. Similarly when returns are received they are called “cash in flows. Cash out flow is denoted by mentioning
the figure within bracket like (50 lacs)

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Chapter: Two – Time Value of Money

Step 1 = to construct the future returns including the principal amount

Year from now Payment expected (cash inflow)
1 Rs.100/-
2 Rs.100/-
3 Rs.100/-
4 Rs.100/-
5 Rs.1100/-

Step 2 = discounting the payment expected by the rate of return, i.e., 8% p.a., we can determine the
present value of the future cash flows. It is Rs.1080.30. This means that an investor will be willing to
purchase this bond now from the market provided the market price of this bond is less than
Rs.1080.30.

Exercise No. 3
We have a bond with the face value of Rs.5,000/-. The interest on the bond is Rs.600/- per year. We
are supposed to get a premium on the bond of Rs.250/- at the end of the maturity period. Expected
rate of return by us = 10% p.a. Suppose the maturity is after 5 years, what is the price at which an
investor would be willing to purchase it from us?
(Note – please add the premium amount to the face value. You will get Rs.5,250/- on maturity)
Answer: Present value of future returns = Rs.5534/-. An investor will be willing to pay
anything less than this value for purchasing the bond from you.

Example no. 8 - Application 3

Evaluation of opening of a branch office by discounting the expected future returns at a suitable rate
of discount and comparing the present value with the investment required in capital assets to open a
branch office.
As you will have realised by now, the investment in a branch office is very similar to investment in a
project. You are investing in a project to get returns from it. Similarly, you invest in a branch office
based on expectation of additional returns.
As it is very similar to a project, separate example or exercise is not given here.

Example No. 9 - Application 4

Suppose we develop a product by spending say Rs.10 lacs. This amount will be recovered along with
profit through sales of a number of units over a period of time. Suppose we project sales in unit terms
as well as value terms over a period of time. Let us assume this period to be three years. Suppose the
expected rate of return is 15% p.a. Further, assume projected sales for the next three years to be as
under:
No. of units expected to be sold Unit Rate Expected sales in lacs of Rupees
2000 Rs.250/- Rs.5 lacs
2200 Rs.250/- Rs.5.5 lacs
2500 Rs.250/- Rs.6.25 lacs

This is similar to finding out the net present value in the case of projects. We discount the expected
sales by the expected rate of return of 15% p.a. This determines the present value of the expected
sales. Let us compare this with the total product development expenses.

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Exercise No. 4
Find out the net present value in the above example. Also confirm that the total product development
costs stand fully recovered at T3.

Answer – The product development costs stand fully recovered at T3.

Let us summarise what we have learnt on application of “Time value of money” to business
♦ Compounding and discounting have a number of applications to Finance decisions.
♦ Compounding has greater application to personal investment while discounting has greater
application to business.
♦ Discounting is useful in a number of decisions like project, product development, opening a
branch office etc.
♦ Bond valuation is also done through discounting.
Let us look at one more example for reinforcing our learning. Let us select the
best project out of the three projects proposed.
Consider the following 3 alternative projects. Assumptions are also given below:

Investment at T0 for all the projects is Rs.500 lacs.

Future cash flows are considered for T1 to T5.

Although the scale of operations for all the projects is the same, the projects have different future
earnings or returns.
The promoters expect a rate of return of 15% p.a. hence; this is the rate by which the future returns
are discounted.

(Rupees in Lacs)
Project 1 Project 2 Project 3

Year Future Future Disc. Future

Disc. Value Disc. Value
No. Earnings Earnings Value Earnings

1 100 150 130.44 175

86.96 152.18
2 120 150 113.42 150
90.73 113.42
3 200 150 98.63 180
131.5 118.35
4 250 200 114.36 225
142.95 128.66
5 250 200 99.44 250
124.3 124.3
Total 556.29
576.4 636.91

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As Project 3 has the highest NPV it would be selected. NPV = PV of future earnings (-) original
investment. Accordingly, the net present values for the three projects would be:
Project 1 76.44 lacs
Project 2 56.29 lacs
Project 3 136.91 lacs
On the basis of net present value, project 3 would get selected.

Concept of annuity
So far we have seen the following in respect of application of time value of money:

Investment lump sum at T0 and get lump sum at Tn = Future value; process is “compounding”. This is
called future value of a single stream.
Suppose we are given a future value and want to know how much should be invested at present. We
use the process that is converse of compounding and this is called “discounting”. In order to get lump
sum after a given period, we should invest the present value at the beginning, again a lump sum. This
is called the present value of a single stream.

Invest lump sum at T0 in a project and get annual returns. The returns will not be equal to each other.
To determine the present value of the future returns to determine Net Present Value = Present value;
process is “discounting”. This is the example of present value of multiple streams.
Annuity refers to “multiple stream” of cash flows but which are equal to each other and
occurring annually. The cash flows could either be in flows or out flows. This means that the following
alternatives are available to us when we are talking of “annuity”.
♦ We invest at the beginning one lump sum amount and get returns over a period of time
that are equal to each other. The cash in flows that are equal to each other are called
“annuity”. Herein we use what is known as Present Value Interest Factor Annuity
(PVIFA). We multiply the Annuity by this factor and get the present value of the future
cash flows in one shot. Then we compare this present value with our proposed investment
at T0 taking decision on investment. We invest provided the Present value of future
annuities is at least equal to our investment at T0.
♦ We invest in equal instalments over a period of time and get one lump sum at the end of
the period. The cash outflows that are equal to each other are called “annuity”. Herein
we use what is known as Future Value Interest Factor Annuity (FVIFA) .We multiply
the Annuity by this factor and get the future value of the cash out flows in one shot.
Let us study the following examples to understand the concept of “annuity”.
Example no. 10

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We are able to invest every year Rs.1000/- for a period of 5 years. We expect a return of 10% p.a.
What will be the value of this investment at the end of 5 years?
Let us represent this by way of a timeline

At T0 T1 T2 T3 T4
T5
Investment = zero 1,000/- 1,000/- 1,000/- 1,000/- 1,000/-
Can we use the future value formula, find out the future value of each stream of Rs.1000/- and add
them up? Thus T1 investment would earn interest for 4 years, the 2 nd year investment would earn
interest for 3 years, the 3rd year investment would earn interest for 2 years, the 4 th year investment
would earn interest for 1 year and the last year investment would not earn any interest. Instead of
doing such an elaborate exercise, we use the alternative “FVIFA”.
Practical applications of “Annuity”4 for future value
♦ Life Insurance policy premium
♦ Recurring deposit account with a bank

Example no. 11

Similar in concept to Example no. 10, we can think of investment lump sum at T0 and getting returns
over a period of time, the returns being equal in value. Example is investment in bank deposit floated
by competitive banking industry at present. Each return will be partly principal amount and partly
interest amount. Our aim is to determine the present value of the future returns by discounting them
and comparing the present value with our investment value.

Can we use PVIF and find out the present value of future cash flows? Yes. The cash flow at T 1 is
discounted for one year, the cash flow at the end of the second year is discounted for two years, the
cash flow at the end of the third year is discounted for three years and so on and so forth. Instead of
repeating the discounting process so many times, we have the easy alternative of Present Value
Interest Factor Annuity.
It is okay for discussion. However the students will be interested in knowing as to where he will get the
PVIFA and FVIFA values. These will be available as annexure with any standard textbook on “Financial
Management” and multiply with the annuity to arrive at the Present Value or Future value as the case
may be.

Concept of perpetuity
This is the concept applicable in the case of pension. Pension is taken to be perpetual. Can we find out
the lump sum amount in case the pension amount is given?
Example no. 12
Suppose the pension amount is Rs. 1000/-. The expected rate of return is 10% p.a. What is the core
amount out of which interest is paid? The annual payment is Rs.12,000/-. Hence the lump sum amount
is Annual payment/rate of interest expressed in decimals.
Accordingly the lump sum amount is Rs. 12,000/0.1 = Rs. 1,20,000/-.

Questions for reinforcement of learning and numerical exercises for practice

4
Annuity could be at a frequency more than one year. In fact in the case of recurring deposit, the annuity is
monthly.

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Subject: Financial Management
Chapter: Two – Time Value of Money

1. Why should return from a project be the highest in the 4-tier interest rate structure?
2. Future value interest factor x Present value interest factor = -----------------------
3. Can you find out the present value of a stream of annuity without using PVIFA? Explain the
process.
4. Find out the present value of a sum of Rs. 10 lacs at the end of five years in case the expected rate
of return is 12% and the compounding is done on half-yearly basis.
5. Suppose you open a recurring deposit account with annual interest of 6%. You open it for a period
of 12 months. The annuity is Rs.500/-. What will be the value at the end of one year?
6. Mr. George is about to retire. The employer places before him two alternatives. Mr. George has to
choose between them. Lump sum Rs. 12 lacs or half-yearly pension of Rs. 79,000/-. Which one
should he choose in case the annual expected return is 10%?
7. What is the present value of an income stream that provides Rs. 2,000/- at the end of year one, Rs.
5000/- at the end of year two and Rs.10,000/- for the next 5 years? Assume the rate of interest to
be 8% p.a.

8. What is the present value of Rs. 5,000/- receivable annually for 30 years if the first receipt occurs
after 5 years and the rate of interest is 10% p.a?

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