The Time Value of

Money
 Which would you rather have --Rs 1,000
today or Rs1,000 in 5 years?

Obviously, Rs1,000 today.

today
 Money received sooner rather than later
allows one to use the funds for
investment or consumption purposes.
This concept is referred to as the TIME
VALUE OF MONEY!!
MONEY
What is time value of
money?


It is the value of money figuring in a given
amount of interest earned over a given
amount of time.
 Why TIME?
  TIME allows one the opportunity to postpone
consumption and earn INTEREST.
INTEREST
 NOT having the opportunity to earn interest
on money is called OPPORTUNITY COST.

How can one compare
amounts in different time
periods?
One can adjust values from different time
periods using an interest rate.

Remember, one CANNOT compare numbers
in different time periods without first
adjusting them using an interest rate.
 Time lines
0 1 2 3

10%

100 FV = ?

5
Types of Interest
◆S im p le In te re st
In te re st p a id ( e a rn e d ) o n o n ly th e
o rig in a la m o u n t, o r p rin cip a l,
b o rro w e d ( le n t).
Compound Interest
 Interest paid (earned) on any previous
interest earned, as well as on the
principal borrowed (lent).
Simple Interest
Formula


Formula SI = P0(i)(n)
 SI: Simple Interest
 P0: Deposit today (t=0)
 i: Interest Rate per Period
 n: Number of Time Periods
Simple Interest
Example
Assume that you deposit Rs1,000 in
an account earning 7% simple
interest for 2 years. What is the
accumulated interest at the end of
the 2nd year?
SI = P0(i)(n) =
Rs1,000(.07)(2) =
Rs140
Simple Interest (FV)
What is the Future Value (FV)
FV of the
deposit?
 FV = P0 + SI =
Rs 1,000 + $140 = Rs 1,140
Future Value is the value at some future
time of a present amount of money, or
a series of payments, evaluated at a
given interest rate.
Simple Interest (PV)
What is the Present Value (PV)
PV of the
previous problem?
 The Present Value is simply the
Rs1,000 you originally deposited.
That is the value today!
Present Value is the current value of a
future amount of money, or a series of
payments, evaluated at a given
interest rate.
 Why Compound
Interest?
Future Value of a Single $1,000 Deposit
Future Value (U.S. Dollars)

20000
10% Simple
15000 Interest
10000 7% Compound
Interest
5000 10% Compound
Interest
0
1st Year 10th 20th 30th
Year Year Year
Compound Interest
Graphically
4500
3833.7
4000
5%
3500
10%
3000
15%

2500 20%

2000 1636.6
treV
al F
u

1500

1000
672.75

500 265.3

0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
Years
 

 Do You want to Double

Your Money?


 How long does it take to double Rs.5,000 at

a compound rate of 12% per year?


13
The “Rule of 72” &
“Rule of 69”
 By rule 72
 Years to Double = 72 / i%


By rule 69


 Years to Double = 0.35+(69 / i%)

14
Actual time- 6.12 years
By rule of 72- 6 years

By rule of 69- 6.10 years



 Doubling period: It is a period in which the

amount invested becomes double.

15
Finding the growth rate
The rate of interest at which the amount is
invested, is called the growth rate.
 We can find the growth rate by using the formula

of future value.
Question:

A bank offers you to deposit Rs.100 and promises

to pay Rs.112 after 1 year. What rate of interest

would you earn?
Ans:-12

16
 Future value


Future value of a single amount
Future value of an Annuity

17
Future Value: is the value at some future
time of a present amount of money, or
a series of payments, evaluated at a
given interest rate.
Present Value: is the current value of a

future amount of money, or a series of

payments, evaluated at a given interest
rate.
Compounding: The process of calculating

future values of cash flows.

Discounting: The process of calculating

present values of the cash flows.

18
Abbreviations
PV - Present value
FV - Future value
Pmt - Per period payment amount
N - Either the total number of cash flows or
the number of a specific period
i - The interest rate per period
Future Value – using Formula
FV n = PV ( 1 + i) n

Where FVn = the future of the investment at the

end of “n” years
i= the annual interest (or discount) rate
n = number of years
PV = the present value, or original amount
invested at the beginning of the first year

20
Future Value Example
 Example: What will be the FV of Rs1000 in 8
years at interest rate of 10%?


FV2= PV(1+i)n = 1000 (1+.1)8

Rs100 (1.10)8 = Rs2144


21
Future Value – Using Tables
FVn = PV (FVIFin, )
Where FVn = the future of the investment at
the end of n year
PV = the present value, or original
amount invested at the
beginning of the first year
FVIF = Future value interest factor or
the compound sum of Rs1
i = the interest rate
n = number of compounding periods

22
Future Value – using
Tables
What is the future value of Rs500
invested at 8% for 7 years? (Assume
annual compounding)
Using the tables, look at 8% column, 7
time periods to find the factor 1.714

FVn = PV (FVIF8%,7yr )
 = Rs500 (1.714)
 = Rs 857
23
Table
Y ear 1%
for
2%
Future
3% 4%
Value
5% 6% 7% 8
1 1.010 1.020 1.030 1.040 1.050 1.060 1.070 1
2 1.020 1.040 1.061 1.082 1.103 1.124 1.145 1
3 1.030 1.061 1.093 1.125 1.158 1.191 1.225 1
4 1.041 1.082 1.126 1.170 1.216 1.262 1.311 1
5 1.051 1.104 1.159 1.217 1.276 1.338 1.403 1
6 1.062 1.126 1.194 1.265 1.340 1.419 1.501 1
7 1.072 1.149 1.230 1.316 1.407 1.504 1.606 1
Future Value-Using Excel
=FV(Rate,years,pmt)
 Future value of a
Annuity
Annuity: An Annuity is a stream of
constant cash flow occurring at
regular intervals of time.
The premium payments of a life

insurance policy.
Deferred Annuity: When the cash flow

occur at the end of each period the

annuity is called deferred or
ordinary annuity.
Annuity Due: When the cash flow

occur at the beginning of each

period the annuity is called annuity
due.
26
Examples of Annuities
 Student Loan Payments
 Car Loan Payments
 Insurance Premiums
 Mortgage Payments
 Retirement Savings
Growth of a 5yr $500 Annuity
Compounded at 6%
0 1 2 3 4 5
6%

500 500 500 500 50

0

28
FV Annuity – Example
What will be the FV of 5-year Rs500
annuity compounded at 6%?


FV5 = 500 (1+.06)4 + 500 (1+.06)3 +500(1+.06)2+



 500 (1+.06) + 500



 = 500 (1.262) + 500 (1.191) + 500 (1.124)+

 500 (1.090) + 500
 = 631.00 + 595.50 + 562.00 + 530.00 +
500
 = Rs.2,818.50 29
 Future value of annuity: The compound value
of annuity.

FVA = A ( [(1+i)n - 1] / i )
 The term within the brackets is the compound
value factor for an annuity.


30
FV of an Annuity – Using
Formula
What will Rs500 deposited in the bank every year
for 5 years at 10% be worth?
FV = PMT {(FVIFi,n -1)/ i }
Simplified form of this equation is:


 FV5 = PMT (FVIFAi,n )

 = PMT [ (1+0.10)5-1 ]/i
 = Rs500 (5.637)
 = Rs2,818.50



31
Future Value of Annuity—
Using Tables
I deposit Rs 1000 annually in a bank for 5 years
and my deposits earn a compound interest of
6%?
What will be the value of these series of deposits at

the end of 5 years?

 FVAn=A[(1+r)n-1]/r
[(1+r)n-1]/r=Future value of interest factor for an

annuity
 =FVIFAr,n
 =FVIFA6%,5
 =1000(5.637) (From table)
 =Rs 5637
Future Value of Annuity

Year 1% 2% 3% 4% 5% 6%
1 1.000 1.000 1.000 1.000 1.000 1
2 2.010 2.020 2.030 2.040 2.050 2
3 3.030 3.060 3.091 3.122 3.153 3
4 4.060 4.122 4.184 4.246 4.310 4
5 5.101 5.204 5.309 5.416 5.526 5.
Applications of Future value
of Annuity

What lies in store for you?

Finding the accumulated PPF


Annual Deposit in a Sinking Fund?

Finding the Interest Rate?
How long should you wait?

 Sinking
Fund
Sinking fund is a fund, which is created out
of fixed payments each period to accumulate
to a future sum after a specified period. For
example, companies generally create sinking
funds to retire bonds (debentures) on
maturity.
The factor used to calculate the annuity for a
given future sum is called the sinking fund
factor (SFF).

 i 
A = Fn  
 (1 + i ) n
− 1 
Futura Limited has an obligation to redeem Rs
500 million bonds 6 years hence.How much
should the company deposit annually in a
sinking fund account wherein it earns 14 %
interest to cumulate 500 million in 6 years
time?


 A=500[0.14/ {(1+0.14)6-1}]
 =58.575 million



Using Excel
Present Value(PV)
Future Value(FV)

Equal Periodic receipt/payment(pmt)

Number of periods(N
per)
 Interest/Discount Rate(Rate)

 Present value
Present value of a Single Amount
Present value of an Uneven series
Present value of an Annuity


38
 Present value of a Single
 General formula: Amount
 PV0 = FVn / (1+i)n


Q. Assume that you need Rs1,000 in 2 years. Let’s

examine the process to determine how much you
need to deposit today at a discount rate of 7%
compounded annually.
PV = FV / (1+i) 2 = Rs.1,000 / (1.07) 2
0 2
 = FV2 / (1+i)2 = Rs.873.44



39
Pre se n t V a lu e – U sin g Ta b le s
P V n = FV ( PVIF in
, )

W h e re PV n = th e p re se n t va lu e o f a fu tu re su m o f
money
FV = th e fu tu re va lu e o f a n in ve stm e n t a t
the end of an investment period
P V IF = Pre se n t V a lu e in te re st fa cto r o f $ 1
i = th e in te re st ra te
n = n u m b e r o f co m p o u n d in g p e rio d s

40
Present Value – Using
Tables
What is the present value of Rs 100 to be
received in 10 years if the discount rate is 6%?
Find the factor in the table corresponding to 6%
and 10 years
 PVn = FV (PVIF6%,10yrs. )
 = Rs100 (.558)
 = Rs55.80

41
Year 1% 2% 3% 4% 5% 6%
1 0.990 0.980 0.971 0.962 0.952 0.943
2 0.980 0.961 0.943 0.925 0.907 0.890
3 0.971 0.942 0.915 0.889 0.864 0.840
4 0.961 0.924 0.888 0.855 0.823 0.792
5 0.951 0.906 0.863 0.822 0.784 0.747
6 0.942 0.888 0.837 0.790 0.746 0.705
7 0.933 0.871 0.813 0.760 0.711 0.665
8 0.923 0.853 0.789 0.731 0.677 0.627
9 0.914 0.837 0.766 0.703 0.645 0.592
10 0.905 0.820 0.744 0.676 0.614 0.558
Uneven cash flow
stream
 Any series of cash flow that does not
conform to the definition of an annuity
 is considered to be an uneven cash flow
stream.
Eg. A series such as: Rs 1000/-,Rs 1000/- ,
Rs 1000/-, Rs 2000/- ,Rs 2000/- , Rs 2000/-
would be considered an uneven cash flow
stream . We might consider it as a series of
two consecutives annuities.

43
 Present value of an
uneven series
 In financial analysis we often come across
uneven cash flows streams then to calculate
the present value we use the

PV= A1/(1+r) + A2/(1+r)2+……An/ (1+r)n


Ex. Uneven Cash flowduringvarious years.




0 1 2 3 4
 10
%
10 30 30 -
0 0 0 50
44
Present Value of an Annuity
Pensions, insurance obligations, and
interest owed on bonds are all annuities.
To compare these three types of
investments we need to know the
present value (PV) of each.
PV can be computed using calculator,
tables, spreadsheet or formula.

45
Present Value of an
Annuity
Using the example, and assuming a discount
rate of 10% per year, we find that the present
P
V

value is:
A
1
(
1
0
0
= 1
.1
0 ) (
1
1
0
0
+ 2
.1
0 ) (
1
1
0
0
+ 3
.1
0 ) (
1
1
0
0
+ 4
.1
0 )
1
(
1
0
0
+ 5
.1
0 )
=
3
7
9 .0
8

62 . 09
68 . 30
75 . 1
82
3 .
6
90 .. 08
379 10 10 10 10 10
4
0 0 0 0 0
0 1 2 3 4 5
 Present Value of an
Annuity
General formula:
PV= A/(1+r) + A/(1+r)2+……A/ (1+r)n


OR
 PV = A (PVIFA)


Ques: Suppose you expect to receive Rs

1,000/- annually for 3 years , at the end
of each of the year . What will be the
present value of this stream if the
discount rate is 10%?
Ans : Rs 2486.8/-

 47
PV of an Annuity – Using Table
§ Calculate the present value of a $500
annuity received at the end of the year
annually for four years when the discount
rate is 6%.


PV = PMT (PVIFAi,n )

 = Rs500(3.465) (From the table)
 = Rs 1732.50

48
 PV of an
Year 1%
A n2%n u ity
3% 4% 5%
1 0.9901 0.9804 0.9709 0.9615 0.9524 0
2 1.9704 1.9416 1.9135 1.8861 1.8594 1
3 2.9410 2.8839 2.8286 2.7751 2.7232 2
4 3.9020 3.8077 3.7171 3.6299 3.5460 3
APPLICATIONS OF PRESENT
VALUE OF ANNUITY
Ø How much can u borrow for an item
Ø Period of loan Amortization
Ø Determining the periodic withdrawal
Ø Finding the Interest Rate

50
Amortized Loans
Loans paid off in equal installments over
time are called amortized loans.

For example, home mortgages and auto
loans.

Reducing the balance of a loan via annuity
payments is called amortizing.



51
 Amortized Loans
The periodic payment is fixed. However,
different amounts of each payment are
applied towards the principal and interest.
With each payment, you owe less towards
principal. As a result, amount that goes
toward interest declines with every
payment (as seen in figure 5-3).

52
Amortized Loans

53
 Steps to Amortizing a
Loan
1. Calculate the payment per period.
2. Determine the interestin Period t.
(Loan Balance at t-1) x (i% / m)
3. Compute principal payment in Period
t. (Payment - Interest from Step 2)
4. Determine ending balance in Period t.
(Balance - principal payment from
Step 3)
5. Start again at Step 2 and repeat.
Amortization Example
 Example: If you want to finance a new
machinery with a purchase price of $6,000
at an interest rate of 15% over 4 years, what
will your annual payments be?


55
 Payments – Using
Formula
Finding Payment: Payment amount can be
found by solving for PMT using PV of annuity
formula.
PV of Annuity =PMT [1-(1+i)-1 ]
 I
 6,000 = PMT (2.855)
 PMT = 6,000/2.855
 = Rs2,101.58

56
Amortization Schedule

Yr. Annuity Interest Principal Balance

1 Rs 2,101.58 Rs900.00 Rs1,201.58 Rs4,798.42

2 Rs2,101.58 719.76 1,381.82 3,416.60

3 2,101.58 512.49 1,589.09 1,827.51

4 2,101.58 274.07 1,827.51 -0-

57