VALUE OF MONEY

DR. AJAYA KUMAR PANDA

Exercise: A
 Suppose Mr. Ramesh wants to construct a pension fund for himself. At
present he is 30 years old and he wants to receive pension of Rs. 50,000 per
month starting from age of 50 to 90 years. If market interest rate is 9% p.a.
for the entire investment period, how much he should invest per month?
Exercise: B
Suppose a 40 yr. old employee who is expecting to retire at age of 60 is
planning for his retirement. At present he estimates that he can live
comfortably with ₹24,000 per year in terms of present rupee value. How
much should he save/invest each year until his retirement so that he can start
getting pension at the end of 21st from now till 10 years, that can allow him to
live as comfortably as he desired now.
 Future Value (FV):
FV = Principal + interest, if i = 10%, P = 100
F1 = 100 + (0.10 × 100) = 100 × (1.10) = 110
F2 = [100 + (0.10 × 100)] + 0.10 [100 + (0.10 × 100)]
= 100 × (1.10) × (1.10) = 121
Or F2 = F1 × 1.10 = 121

In case of simple interest: F2 = 100 + [2 × (0.10 × 100)] = ₹120

In case of compounding interest: F2 = ₹121,
i.e. excess ₹1 is interest on interest.
Symbolically:
FV1 = PV + (PV × i) or PV (1 + i)
FV2 = FV1 × (1 + i)
Or FV2 = PV × (1 + i) (1 + i) = PV × (1 + i)2
.
FV5 = PV (1 + i)5
.
.
.FVn = PV (1 + i)n
(1 + i)n = Compound value factor (CVF)
FVn = PV × CVFn,i
Example:
If you deposit ₹1000 in a bank at 5% interest rate P.A. Then in future
FV1 = 1000 (1.05) = ₹1050.00
FV2 = 1000 (1.05)2 = ₹1102.50 or 1050 (1.05) = 1102.5
FV3 = F2 (1 + i) or PV (1 + i)3
= 1102.5 (1.05) = 1157.6 or 1000 (1.05)3 = 1157.6

Similarly,
FV15 = 1000 (1.05)15
Growth of Rs. 1 at different n and i
Example 1:
You have ₹10,000 and you want ₹16,105 after 5 year. Then at what
interest rate you should invest it?
Ans: The ratio of cash flow consists,
16,105 / 10,000 = 1.6105
That is, you must earn an interest that will allow ₹1 to grow up to ₹1.6105
at 5 years. That is
10,000 (1 + i)5 = ₹16105
(1 + i)5 = 1.6105
i = 10%
10,000 (1.1)5 = 16105.1
At What rate Principal should Grow?
 Present Value (PV):
FV1 = PV (1 + i)
PV = FV1 / (1 + i)
If FV1 = 100 (1.10) = 110
Then PV = 110 / (1.10) = 100
FV2 = PV (1 + i)2 = 100 (1.10)2 = 121
Then PV = FV2 / (1 + i)2 = 121 / 1.21 = 100
PV = FVn / (1 + i)n or FVn × [1/ (1 + i)n]

[1/ (1 + i)n] = Discount factor or present value factor (PVF)

PV = FVn × PVFn,i
PV of ₹1 over n time period
Example 2:
Suppose you have an expected Cash Flow of ₹50,000 to be received
after 5 years from now. What is interest PV, if i = 9% ?
Ans: PV = 50,000 / (1 + 09)5 = 50,000 / (1.09)5
= 50,000 / 1.5386 = ₹32,497.07

1 / 1.5386 = 0.6499 = PVF5, 9% for n = 5 and i = 0.09

Similarly, for 10 Years;

PV = 50,000 / (1.09)10 = 50,000 / 2.3074 = ₹21,1201.21
1 / 2.3674 = 0.4224 = PVF10, 9% for n = 10 and i = 0.09
Example 3:
Mr. X want to sell his land. Buyer 1 offers ₹10,000 now, whereas buyer 2
offers ₹11424 after 1 year. If market interest rate is 12%, what should Mr.
X do?

Ans: PV of 11424 = 11424 / 1.12 = ₹10,200

Secondly, if Mr. X prefers to sell it to buyer 1 at 10,000, then after 1year.
FV of 10,100 = 10,000 × (1.12) = ₹11,200
According to PV, buyer 2 is giving more (10,200) than buyer 1 (10,000).
According to FV of buyer 1, it is less than buyer 2. Hence, Mr. X should
prefer to sell it to buyer 2.
 Example 4:
Mr. X, a financial analyst thinks that price of land that cost ₹85,000 will
certainly grow up to ₹91,000 by next year and recommends Mr. Y to buy it.
Given market interest rate of 10%, should Mr. Y accept the advice of Mr. X
to buy the land?
Ans: (a) As per FV = 85000 × (1.10) = ₹93,500
Which is much more than appreciated price of land after 1 year (91,000).
(b) As per PV, 91,000 / (1.10) = ₹82,727.27
which is much less than initial investment.
(c) As per the interest gain
85,000 (1 + i) = 91,000
=> (1 + i) = 91000 / 85000 = 1.0706 (i.e.) i = 0.0706 or 7.06%
Finding out No. of Periods (n):
Example 5:
You wanted to have ₹50,000, but at present you have ₹25,000. If you
invest your ₹25,000 at 12% interest rate per annum, then how long it
will take you to make your investment ₹25,000.

Ans: 25,000 × (1.12)n = 50,000 or 50,000 / (1.12)n = 25,000

(1.12)n = 2
n = 6 years
Example 6:

You have ₹2.3 million. If you invest it at 5% P.A interest rate, then how
long it will take you to make your investment ₹10 million.

Ans: ₹23,00,000 × (1.05)n = 10,000,000

1.05n = 10,000,000 / 2,300,000 = 4.35
n = 30 years
 Time Value in case of continuous CF
1. Annuity 2. Growing Annuity 3. Perpetuity and 4. Growing Perpetuity

Annuity: Annuity is a fixed cash flow (payments/receipts) for a specified

no. of times. House rent, car loan, house loan etc. are examples of annuity.

Suppose a fixed sum of rupees i.e. ₹1.00 is deposited in a savings bank a/c
@ 6% interest P.A for 4 years. Then how the annuity will grow.
Cont…..
CF1 has a scope to grow for 3 years at 6% P.A rate i.e.
1(1.06)3 = 1.191
CF2 has a scope to grow for 2 years at 6% P.A rate i.e.
(1.06)2 = 1.124 and
Similarly, CF3 = (1.06)1 = 1.06
CF4 = 1.00
The aggregate compounded value of ₹1.00 deposited at the end of each
year for 4 years would be 1.191 + 1.124 + 1.06 + 1.00 = ₹4.375.
The above example can be expressed
FV4 = A (1 + i)3 + A (1 + i)2 + A (1 + i)1 + A
= A [(1 + i)3 + (1 + i)2 + (1 + i)1 + 1]
.
FVn = A + A (1 + i)1 + A (1 + i)2 + …… + A (1 + i)n-1
FVn = A [1 + (1 + i)1 + (1 + i)2 + …… + (1 + i)n-1]………….(1)

 Now multiply (1 + i) in both sides of equation (1)

FVn (1 + i) = A [(1 + i) + (1 + i)2 + (1 + i)3 + …… + (1 + i)n]………….(2)
Subtract equation (2) from equation (1)
FVn (1 + i) – FVn = A [(1 + i)n -1]
FVn + FVni - FVn = A [(1 + i)n -1] (3)
Rearranging the above equation 3;

𝟏 + 𝒊 𝒏 −𝟏 𝟏 + 𝒓 𝑻 −𝟏
𝑭𝑽𝒏 = 𝑨 [ ] or 𝑨[ ]
𝒊 𝒓

𝟏+𝒊 𝒏 𝟏 𝟏+𝒓 𝑻 𝟏
𝑨[ − ] or 𝑨[ − ]
𝒊 𝒊 𝒓 𝒓

Hence FVn = Annuity CF × Compounded value factor for annuity

1 + 𝑖 𝑛 −1
[ ] = Compounded value factor for annuity (CVFAi,n)
𝑖
Or Future value interest factor for annuity (FVIAi,n)
Example 10:
Suppose, you are investing ₹5000 at the end of each year for 4 years at
6% P.A interest. Find out the future value of your investment at the end
of 4 years i.e. FV4?

1.06 4 −1
Ans: 𝐹𝑉4 = 5000 [ ] = ₹5000 × 4.3746 = ₹21,873.00
0.06
Example 11:
Suppose you invest ₹3000 per year in investment fund at 6% P.A
interest rate for 30 years. How much will you have, when you retire in
30 years.

1.06 30 −1
Ans: 𝐹𝑉30 = 3000 [ ] = 3000 × 79.0582 = ₹2,37,174.56
0.06
Sinking Fund Factor (SFF)
FVn = A × CVFAn,i
A = FVn × (1 / CVFAn,i)
1 / CVFAn,i = SFFn,i
A = FVn × SFFn,i

𝑖 𝑟
𝑆𝐹𝐹𝑛,𝑖 = [ 𝑛 ] or [ 𝑇 ]
1+𝑖 −1 1+𝑟 −1

𝒊
𝑨 = 𝑭𝑽𝒏 [ 𝒏
]
𝟏+𝒊 −𝟏
 You want to accumulate ₹2,37,174.56 at the end of 30 years. How much
you should invest every year at 6% P.A interest rate so that, you will be
able to have the above stated amount at the end of 30 years?
𝑖
𝐴 = 𝐹𝑉30 [ 30 −1 ]
1+𝑖
0.06
i.e. 2,37,174.56 [ 30 ]
1.06 −1

= 2,37,174.56 × 0.0126
= ₹2,999.999 or ₹3000.00 P.A
SFF is used to calculate annuity for a given sum.
Present value of an annuity
Suppose you have an opportunity to receive ₹1.00 for 4 years (at the
frequency of end of each year for 4 years). If your required rate of
interest is 10%, then calculate the PV of the annuity?
 Ans:
P1 = 1 / (1.1) = 0.909
P2 (PV of CF2) = 1 / (1.1)2 = 0.826
P3 (PV of CF3) = 1 / (1.1)3 = 0.751
P4 (PV of CF4) = 1 / (1.1)4 = 0.683
The aggregate PV = ₹3.169
The computation of the above PV of annuity can be written as.

𝐴 𝐴 𝐴 𝐴
𝑃= + + + ⋯+ [ ] ……. (1)
(1+𝑖) 1+𝑖 2 1+𝑖 3 1+𝑖 𝑛

1 1 1 1
=𝐴 + + + ⋯+ [ ] ……. (2)
(1+𝑖) 1+𝑖 2 1+𝑖 3 1+𝑖 𝑛

Multiply 1 / (1 + i) in equation (1)

𝑃 𝐴 𝐴 𝐴
= + + ⋯+ [ ] ……. (3)
(1+𝑖) 1+𝑖 2 1+𝑖 3 1+𝑖 𝑛+1
Subtract equation (1) from (3)

𝑃 𝐴 𝐴
𝑃− = − [ ] ……. (4)
1+𝑖 (1+𝑖) 1+𝑖 𝑛+2

Now multiply both side of equation (4) by (1 + i) we get;

𝐴
𝑃 1+𝑖 −𝑃 =𝐴−
1+𝑖 𝑛

1
𝑃 + 𝑃𝑖 − 𝑃 = 𝐴[1 − 𝑛 ]
1+𝑖

1
1− 1+𝑖 𝑛
And 𝑃 = 𝐴 [ ]
𝑖
Hence Present value of an annuity can be calculates as:

(1+𝑖)𝑛 −1 1 1
𝑃= 𝐴[ 𝑛 ] or 𝐴 −
𝑖 (1+𝑖) 𝑖 𝑖 1+𝑖 𝑛

Where

(1+𝑖)𝑛 −1
[ 𝑛 ] = PV factor of annuity (PVFA)
𝑖 (1+𝑖)

or PV interest factor for annuity (PVIAn,i)

Example 13:
Suppose a person receives an annuity of 5000/- at the end of each year
for 4 years. If market interest rate is 10%, then calculate the present
value of the annuity?

1 1
Ans: 𝑃 = 5000 −
0.1 0.1 1.10 4
= 5000 [10 – 6.830] = 5000 × 3.170 = ₹15,850.00
Example 14:
Saurabh has got a scheme at the name of million rupee scheme as it pay
₹50,000 at the end of each year for 20 years. (50,000 × 20 = ₹1,000,000).
If market interest rate is 8%, what is the PV of the scheme?
Ans:
1
1− 1+𝑖 𝑛 (1+𝑖)𝑛 −1
𝑃𝑉 = 𝐴 [ ] or 𝐴[ ]
𝑖 𝑖 (1+𝑖)𝑛
1
1− 20
1.08
= 50,000 [ ]
0.08
= ₹4,90,905.00

Hence, can the scheme be named as “Million Rupee Scheme”.

Capital Recovery Factor
P = A × PVFAn,i
A = P × (1 / PVFA n,i) or A = P × (1 / PVIA n,i)

(1 / PVFA) n,i = Capital recovery factor

1 𝑖(1+𝑖)𝑛
= [1 1 ] or [ 𝑛 ]
− (1+𝑖) −1
𝑖 𝑖 1+𝑖 𝑛
Example 15:
Suppose you have a loan of ₹10,00,000 today for 4 years to your friend.
If market interest rate is 10%, then how much money per year (EMI) you
should receive to recover your investment?
1 1
Ans: 10,00,000 = 𝐴 −
𝑖 𝑖 1+𝑖 𝑛
1 1
Or 10,00,000 = 𝐴 –
0.10 0.10 1.10 4

1
𝐴 = 10,00,000[ 1 1 ]
–
0.10 0.10 1.10 4

= 10,00,000 × 0.3155
= ₹3,15,500.00
Example 16:
If your employer is providing you an easy loan of ₹50,000 at 9% P.A
interest rate to buy a laptop. If you are asked to repay the loan in 3
equal installments at the end of each year for 3 years, then how much
will be the annual installment for you?
(1.09)3 −1
Ans: 50,000 = 𝐴[ ]
0.09(1.09)3

0.09(1.09)3
Or 𝐴 = 50,000 [ ]
(1.09)3 −1

= 50,000 × 0.3951
= ₹19,755
Present Value of Growing Annuity
In financial decision making, there are number of situations where CFs
grows at a constant rate. There are also inflation protected security
where returns grow at the growth of inflation.
Example 17:
Suppose you have an annuity receivable of ₹1000 at the end of each
year for 5 years and the annuity is expected to grow at 10% each year. If
market interest rate is 12%, then calculate PV of the investment?
Ans:

Year CF
1 1000 (1.10)0 = 1000
2 1000 (1.10)1 = 1100
3 1000 (1.10)2 = 1210
4 1000 (1.10)3 = 1331
5 1000 (1.10)4 = 1469
 1000 1100 1210 1331 1464
𝑃𝑉 = 1
+ 2
+ 3
+ 4
+
1.12 1.12 1.12 1.12 1.12 5

1000 1.10 0 1000 1.10 1 1000 1.10 2 1000 1.10 3 1000 1.10 4
= + + + +[ ]
1.12 1 1.12 2 1.12 3 1.12 4 1.12 5
Representing this in term of formula

𝐴 𝐴(1+𝑔)1 𝐴(1+𝑔)2 𝐴(1+𝑔)3 𝐴(1+𝑔)4

PV = + + + +
1+𝑖 1 1+𝑖 2 1+𝑖 3 1+𝑖 4 1+𝑖 5

1 (1+𝑔)1 (1+𝑔)2 (1+𝑔)3 (1+𝑔)4

PV = A + + + +
1+𝑖 1 1+𝑖 2 1+𝑖 3 1+𝑖 4 1+𝑖 5
 Extending this up to n time period

1 (1+𝑔)1 (1+𝑔)𝑛−1
PV = A + +⋯ +
1+𝑖 1 1+𝑖 2 1+𝑖 𝑛

1 1 (1+𝑔)𝑛
=A −
𝑖−𝑔 𝑖−𝑔 1+𝑖 2

1+𝑔
1−( )𝑛
1+𝑖
=A
𝑖−𝑔
 𝐴 1+𝑔 𝑛
PV = 1−( )
𝑖−𝑔 1+𝑖

1+𝑔
1 1 1+𝑔 𝑇 1−( 1+𝑟 )𝑇
PV = A − × ( ) OR A
𝑟−𝑔 𝑟−𝑔 1+𝑟 𝑟−𝑔

 Now solve the previous problem

1000 1.10 5
PV= 1−( )
0.12−0.10 1.12
= Rs. 50,000 × (1 - 0.9138)
= Rs. 4310
Example 18
Mr. X, a 2nd year MBA student has got a job that pays 8,00,000 per
annum and is expected to grow @ 9% every year till 40 years. Given an
market rate of 20%, calculate the PV. of his lifetime income?

𝟏.𝟎𝟗
𝟏−(𝟏.𝟐𝟎)𝟒𝟎
 PV = 8,00,000 = Rs. 71,17,300.71
𝟎.𝟐𝟎−𝟎.𝟎𝟗
 Present value of perpetuity:
Perpetuity is an annuity that occurs for indefinite time period. It is not very
common in financial decision making. The British bond called “Consol” is
an example of perpetuity. An investor holding a Consol is entitled to
receive yearly interest from British Govt forever.
Look at the PV. of an Annuity formula
1 1
 𝑃𝑉 = 𝐴 −
𝑖 𝑖(1+𝑖)𝑛

When n → ∞, then (1+i)n term reduced to zero and hence, PV. Of a

perpetuity will be
𝐴 𝐶𝐹 𝐶𝐹
 𝑃𝑉 = 𝑂𝑟 𝑂𝑟
𝑖 𝑖 𝑟
Example 19
Consider a Consol is paying £100 per year. If market interest rate is 6% ,
then calculate the PV. of the Consol?

£100
 𝑃𝑉 = = £1666.67
0.06

Hence there exists an inverse relationship between value of perpetuity

and its interest rate.
PV of growing perpetuity:

𝑨 𝑪𝑭
 𝑷𝑽 = 𝑶𝒓
(𝒊−𝒈) (𝒓−𝒈)

In this case, the perpetuity is growing at a constant rate (g).

Loan amortization:
Loan amortization, is known for repayment schedule that specifies the
time schedule for paying interest and principal. This can be done in two
ways:
 Through Balloon payments.
 Through Capital recovery.
Through balloon payments, the loan requires the repayment of
principal in same equal instalments and pay interest on the unpaid loan.
Thus, interest payment will decline over the years and hence the loan
payment (EMI) will not be equal for all the periods.
Example 21
Suppose Mr. X has taken a loan of 5000 @ 9% interest per annum. The
loan has to be paid in 5 instalments where the principal and Interest
will be repaid in 5 equal yearly instalments.

 In case of Balloon payments structure, the payment schedule will be

as follow:
Year Beginning Total Interest paid (I) Principal Year End
balance payment paid (P) balance
( P + I)
1 5000 1450 450 1000 4000
(1000 + 450) (5000×0.09) (5000 -1000)
2 4000 1360 360 1000 3000
(4000×0.09) (4000 -1000)
3 3000 1270 270 1000 2000
(3000×0.09)
4 2000 1180 180 1000 1000
(2000×0.09)
5 1000 1090 90 1000 0
(1000×0.09)
Total 6,350 1350 5000
An alternative way to calculate loan amortization is through Capital
Recovery Factor. In this problem we want to answer the annuity for 5
year @ 9% interest rate p.a. for the present value of Rs. 5000.
A = PV × (1/𝑃𝑉𝐹𝐴 n,i)

𝑖(1+𝑖)𝑛
Or A = 𝑃𝑉
(1+𝑖)𝑛 −1
0.09(1.09)5
= 5000
(1.09)5 −1
0.1385
= 5000 × = 5000 × 0.2571 = ₹ 1285.5
0.5386
Year Beginning Total Interest paid (₹) Principal paid (₹) End balance (₹)
balance (₹) payment (₹)
1 5000 1285.5 450 835.5 4264.5
(5000 × 0.09) (1285.5 - 450) (5000-835.5)
2 4164.5 1285.5 374.8 910.7 3253.8
(4164.5 × 0.09) (1285.5 - 374.8) (4164.5 - 910.7)
3 3253.8 1285.5 292.8 992.7 2261.1
(3253.8 × 0.09) (1285.5 - 292.8) (3253.8 – 992.7)
4 2261.1 1285.5 203.49 1082.01 1179.09
(2261.1 × 0.09) (1285.5 -203.49) (2261.1- 1082.01)

5 1179.09 1285.5 106.12 1179.3 -0.21

(1179.09 × 0.09) (1285.5 - 106.12) (1179.09 - 1179.3)
Total 6427.5 1427.2 5000.3
Estimation Of a Pension Fund
Suppose Mr. Ramesh wants to construct a pension fund for himself. At
present he is 30 years old and he wants to receive pension of Rs. 50,000 per
month starting from age of 50 to 90 years. If market interest rate is 9% p.a.
for the entire investment period, how much he should invest per month?

Ans: The problem has two parts.

Part1: From Age 30 to 50 i.e. 20 years or 240 monthly investments ( - CF)
Part 2: From Age 50 to 90 i.e. 40 years or 480 monthly investments ( + CF)
And Annual interest rate is 9% or 0.75 % per month
Start with Part 2:
If A = ₹ 50,000 n = 480 i = 0.0075 PV = ?

1 1
PV40 = 𝐴 − or
𝑖 𝑖 1+𝑖 𝑛
1 1
PV40 = 50,000 −
0.0075 0.0075 1.0075 480
= 50,000 × 129.6409 = ₹ 64,82,045/-
Part 1:
If FV20 = 64,82,045 n = 240 i = 0.0075
Then calculate the Annuity (A) = ?

𝑖
𝐴 = 𝐹𝑉20 [ 𝑛
]
1+𝑖 −1

0.0075
A = 64,82,045 [ 240 ] = 64,82,045 × 0.001497
1.0075 −1
= ₹ 9703 per month
That is Mr. Ramesh has to invest ₹ 9703 per month now till 20 years
(i.e. up to 50 years of his age) to receive a per month pension of ₹
50,000 for 40 years (i.e. up to 50 years of his age).
Inflation Adjustment of a Pension Fund:
Suppose a 40 yr. old employee who is expecting to retire at age of 60 is
planning for his retirement. At present he estimates that he can live
comfortably with ₹24,000 per year in terms of present rupee value. How
much should he save/invest each year until his retirement so that he can start
getting pension at the end of 21st from now till 10 years, that can allow him to
live as comfortably as he desired now.
Note: At present most of the long term investments in market are
giving an average return of 15% annually, and assume an annual average
inflation rate of 9% P.A for next 30 years.
Answer :- The investor estimates that he can live comfortably with ₹24,000
per year in terms of present rupee value & annual average inflation rate of
9% P.A. Lets calculate the inflation adjusted expected cash flow that is his
estimated annual pension amount.
 Inflation adjusted CF or
Year Age future value of 24000 Pension
21 61 24000 (1.09)21 146611.39
22 62 24000 (1.09)22 159806.41
23 63 24000 (1.09)23 174188.99
24 64 24000 (1.09)24 189866.00
25 65 24000 (1.09)25 206953.94
26 66 24000 (1.09)26 225579.79
27 67 24000 (1.09)27 245881.97
28 68 24000 (1.09)28 268011.35
29 69 24000 (1.09)29 292132.37
30 70 24000 (1.09)30 318424.28
Present Value of the Future CF
146611.39 159806.41 174188.99 + 189866.00 + 206953.94 +
PV20 = + 2 + 3 4 5
1.15 1.15 1.15 1.15 1.15

225580 + 245881.97 + 268011.35 + 292132.37 + 3318424.28

6 7 8 9 10
= ₹10,13,632
1.15 1.15 1.15 1.15 1.15

Similarly, by using formula of constantly growing

𝐴 1+𝑔 𝑛
PV= 1−( )
𝑖−𝑔 1+𝑖
 146611.39 1.09 10
 PV20 = 1−( ) = ₹10,13,632
0.15−0.09 1.15

Now consider PV20 = ₹10,13,632 as FV20 from now and calculate the A
using SFF
𝑖
A = FV [ ]
1+𝑖 𝑛−1

0.15
= 10,13,632 [ 20 ] = 1013632 × 00976 = ₹ 9894.5
1.15 −1
Time Line of the Investment
Hence the person has to invest ₹ 9894.5 at the end of every year starting
at the age of 40 till he reaches the age of 60 in order to withdraw a
₹ 24000 equivalent money value of rupee at the subsequent years for 10
years.
Thank You