SEEMA CHAKRABARTI

The Time Value of Money

Do we prefer to have Rs.1,00,000 now or 10 years from now?
Of course, we all would prefer the money now! This illustrates that there is an inherent monetary value attached to time.
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What is The Time Value of Money?

A rupee received today is worth more than a rupee

received tomorrow
This is because a rupee received today can be

reinvested to earn interest

The amount of interest earned depends on the

general rate of return that can be earned on any investment

Time value of money quantifies the value of a rupee

through time
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Uses of Time Value of Money

Time Value of Money, or TVM, is a concept that is used in all aspects of finance including:
Bond valuation Stock valuation Accept/reject decisions for project management Amortization of loans And many others!

Formulas
Common formulas that are used in TVM calculations:*
Present value of a lump sum:

PV = CFt / (1+r)t
Future value of a lump sum:

FVt = CF0 * (1+r)t

Present value of a cash flow stream:
n

PV = S [CFt / (1+r)t]
t=0

Formulas (continued)
Future value of a cash flow stream:
FV = S [CFt * (1+r)n-t]
t=0 n

Present value of an annuity: PVA = PMT * {[1-(1+r)-t]/r} Future value of an annuity: FVAt = PMT * {[(1+r)t 1]/r}
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Variables
where
r = rate of return t = time period n = number of time periods

PMT = payment
CF = Cash flow (the subscripts t and 0 mean at time t

and at time zero, respectively) PV = present value (PVA = present value of an annuity) FV = future value (FVA = future value of an annuity)

Present Value of a Lump Sum

Present value calculations determine what the value of a

cash flow received in the future would be worth today (time 0)

The process of finding a present value is called

discounting (hint: it gets smaller)

The interest rate used to discount cash flows is generally

called the discount rate

Example of PV of a Lump Sum

1.

How much would Rs. 100 received five years from now be worth today if the current interest rate is 10%? Draw a timeline

?
0 1

i = 10%

Rs100
3 4 5

The arrow represents the flow of money and the numbers under the timeline represent the time period. Note that time period zero is today.
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Example of PV of a Lump Sum

Write out the formula using symbols: PV = CFt / (1+r)t
2.

Insert the appropriate numbers: PV = 100 / (1 + .1)5

3.

Solve the formula: PV = Rs. 62.09

4.

Or Simply: PV = 100 * 0.621 = 62.10 Rs

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Future Value of a Lump Sum

Future value of a sum of money can be taken to be the

opposite of present value

Future value determines the amount that a sum of

money invested today will grow to in a given period of time

The process of finding a future value is called

compounding (hint: it gets larger)

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Example of FV of a Lump Sum

1.

How much money will you have in 5 years if you invest Rs.100 today at a 10% rate of return? Draw a timeline

Rs.100
0
2.

i = 10%

?
4 5

Write out the formula using symbols: FVt = CF0 * (1+r)t

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Example of FV of a Lump Sum

3.

Substitute the numbers into the formula:

FV = Rs.100 * (1+.1)5

4.

Solve for the future value: FV = Rs.161.05 OR Simply, FV = 100 * 1.611 = 161.10

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Present Value of a Cash Flow Stream

A cash flow stream is a finite set of payments that an

investor will receive or invest over time.

The PV of the cash flow stream is equal to the sum of the

present value of each of the individual cash flows in the stream.

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Example of PV of a Cash Flow Stream

1.

Mr. Anil made an investment that will pay Rs.100 in the first year, Rs.300 the second year, Rs.500 the third year and Rs.1000 the fourth year. If the interest rate is ten percent, what is the present value of this cash flow stream? Draw a timeline:

Rs.100

Rs.300

Rs.500

Rs.1000

0
? ? ? ?

4
i = 10%
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Example of PV of a Cash Flow Stream

2.

Write out the formula using symbols:

n t=0

PV = S [CFt / (1+r)t] OR PV = [CF1/(1+r)1]+[CF2/(1+r)2]+[CF3/(1+r)3]+[CF4/(1+r)4] Substitute the appropriate numbers: PV = [100/(1+.1)1]+[Rs.300/(1+.1)2]+[500/(1+.1)3]+[1000/(1.1)4]

3.

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Example of PV of a Cash Flow Stream

Solve for the present value: PV = Rs.90.91 + Rs.247.93 + Rs.375.66 + Rs.683.01 PV = Rs.1397.51
4.

OR Simply, PV = (100 * 0.909) + (300 * 0.826) + (500 * 0.751) + ( 1000 * 0.683), PV = 90.90 + 247.8 + 375.5 + 683

PV = 1397.2 Rs.
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Example of PV of a Cash Flow Stream + ( 1000 * 0.683), PV = (100 * 0.909) + (300 * 0.826) + (500 * 0.751)
1.

PV = 90.90 + 247.8 + 375.5 + 683 PV = 1397.2 Rs. Draw a timeline:

Rs.100

Rs.300

Rs.500

Rs.1000 4
i = 10%
0.683
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0
90.90 247.8 375.5 683

0.909

1
0.826

2
0.751

Future Value of a Cash Flow Stream

The future value of a cash flow stream is equal to the sum

of the future values of the individual cash flows.

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Example of FV of a Cash Flow Stream

1.

Mr. Anil deposits Rs. 500, Rs. 1000, Rs. 1500,Rs.2000 & Rs. 2500 each at the end of each year in his savings account at the rate of 5% for 5 years. Calculate the future value of his investment at the end of 5 years. Draw a timeline:

Rs.500
0 i = 5% 1

Rs.1000
2

Rs.1500 Rs.2000 Rs.2500

3 4

Rs.2500 ? ?
? ?
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Example of FV of a Cash Flow Stream

1. 2.

FV = (500 * 1.216) + (1000 * 1.158) + (1500 * 1.103) + ( 2000 * 1.050) + (2500 * 1.000), FV = 608 + 1158 + 1654.50 + 2100 + 2500 = 8020.50

Rs.500
0 i = 10%
1.216

Rs.1000
2
1.158

Rs.1500 Rs.2000 Rs.2500

1.000

3
1.103

41.050

2500 2100

1654.50 1158 608

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Annuities
An annuity is a cash flow stream in which the cash flows

are all equal and occur at regular intervals.

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Example of FV of an Annuity
1.

Mr. Anil deposits Rs.2000 at the end of each year in his savings account at the rate of 5% for 5 years. Calculate the future value of his investment at the end of 5 years. Draw a timeline:

Rs.2000
0 i = 5% 1

Rs.2000
2

Rs.2000 Rs.2000 Rs.2000

3 4

Rs.2000 ? ?
? ?
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Example of FV of an annuity
1. 2.

FV = (2000 * 1.216) + (2000 * 1.158) + (2000 * 1.103) + ( 2000 * 1.050) + (2000 * 1.000), FV = 2432 + 2316 + 2206 + 2100 + 2000 = 11,054 Rs

Rs.2000
0 i = 5%
1.216

Rs.2000
2
1.158

Rs.2000 Rs.2000 Rs.2000

1.000

3
1.103

41.050

2000 2100
2206 2316 2432
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Example of FV of an annuity
OR Simply,
FV = 2000 * 5.526 = 11052 Rs.

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Example of PV of an Annuity

1.

Mr. Anil wishes to determine the present value of the annuity of cash inflows of Rs. 1000 per year for 5 years. The rate of interest is 10 %. Draw a timeline:

Rs.1000

Rs.1000

Rs.1000

Rs.1000 4

Rs.1000 5

0
? ? ? ? ?

i = 10%
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Example of PV of an Annuity
1.
2. 3.

PV = (1000 * 0.909) + (1000 * 0.826) + (1000 * 0.751) + (1000 * 0.683) + (1000 * 0.621), PV = 909 + 826 + 751 + 683 + 621 = 3790 Rs Draw a timeline:

Rs.1000

Rs.1000

Rs.1000

Rs.1000 4

Rs.1000 5

0
909 826 751 683 621

0.909

1
0.826

2
0.751

i = 10%
0.683
0.621
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Example of PV of an annuity
OR Simply,
PV = 1000 * 3.791 = 3791 Rs.

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PV of an infinite life Annuity Perpetuities )

An annuity that goes on for ever is known as perpetuity.

The present value of a perpetuity of Rs. C carrying interest

rate i is given by: C/i

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PV of an infinite life Annuity Perpetuities )

Example:

The present value of a perpetuity of Rs. 500 discounted @

5% is: PV = 500 /0.05 = Rs. 10,000.

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Some Examples
Assume you will receive an inheritance of Rs.100,000, six years

from now. How much could you borrow from a bank today and spend now, such that the inheritance money will be exactly enough to pay off the loan plus interest when it is received? Assume the bank charges an interest rate of 12 percent?
Sn = P0(1+i)n

so, P0 = Sn/(1+i)n P0 = 100,000/(1.12)6 P0 = Rs.50,663 Or P0 = 100,000 * 0.507(i.e. PVIF) P0 = Rs.50,700

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Some Examples
If you want to save Rs.500,000 for retirement after 30

years, and you earn 10 percent per annum, how much must you save each year?
FV = PMT[(1+i)n - 1]/i 500,000 = PMT[(1.1)30 - 1]/.1 PMT = Rs.3,040 per year Or PMT = 500000 / 164.49 (FVAF) Rs 3039.69 approx or Rs. 3040
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Some Examples
How long will it take for Rs.10,000 to grow to Rs.20,000 at

an interest rate of 15% per year?

Sn = P0(1+i)n
20,000 = 10,000(1.15)n n = 4.96 years (or, about 5 years)

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Some Examples
If you invest Rs.11,000 in a mutual fund today, and it

grows to be Rs.50,000 after 8 years, what compounded, annualized rate of return did you earn?

Sn = P0(1+i)n 50,000 = 11,000(1+i)8 i = 20.84 percent per year

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Some Examples
If you borrow Rs.100,000 today at 9 percent interest per

annum, and repay it in equal annual payments over 10 years, how much are the payments?
PV = PMT[(1+i)n -1]/[i(1+i)n] 100,000 = PMT[(1+.09)10 -1]/[.09(1.09)10] PMT = Rs.15,582 per year Or PMT = 100000 / 6.418 PMT = 15581 per year
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Some Examples
If you invest in a stock that will pay a dividend of Rs.10

next year and grow at 5 percent per year, and you require a 14 percent rate of return, how much is the stock worth to you today?

PV = PMT1/(i - g) PV = 10/(.14-.05) PV = Rs.111.11

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THANK YOU!

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