Time Value of Money (TVM)

 Concept of Time Value of Money ( TVM )

 Need / Reasons for Time Value of Money
 Simple Interest and Compound Interest
 Basic Valuation Techniques

 Compounding / Feature Value Techniques

 Discounting / Present Value Techniques

 Concept of Annuity Due

 Concept of Time Value of Money ( TVM )

 The Central idea behind the theory of “Time Value

of Money” TVM is the fact that the money received today is
worth more then the same amount of money receivable at
the future date.
• Present Money as against the future money is termed as the
“Time Preference for Money”

• “Present” & its value “at a Future date” is referred to as the

“Time Value of Money”
 Need / Reasons for Time Value of Money

1. Risk and Uncertainty

2. Preference for Consumption
3. Investment Opportunities
4. Inflationary Economy
Compounding
 Simple Interest & Compound Interest
Simple Interest : is the interest paid or computed only on the original amount
(Principal) of a loan or on the amount of an account and not on the interest it
has already earned.

Compound Interest : is the interest calculated on the initial principal and also on
The accumulated interest of previous periods of a deposit or loan. It may be
Considered as “Interest on Interest” and it makes a deposit or loan grow at a
Faster rate than that of a “Simple Interest”.
Compound 1 Day 1 Month 3 Month 6 Month 1 Year
Period (Daily) (Monthly) (Quarterly) (Semi-Annually) (Annually)

n
(Fraction of 1 Year ) 365 1/12 1/4 1/2 1

FV = PV ( 1 + n X r)
 Simple Interest & Compound Interest
Example # 1 : If ₹ 1,000 is invested @12% simple interest for 5 Years.
When will be the value of investment after 5 Years?
Solution : FV = PV ( 1 + n X r )

Where,
Future Value (FV) = ?
Present Value (PV)= ₹ 1,000
Number of Years (n) = 5 Years
Interest rate ( r ) = 12%

FV = 1,000 ( 1 + 5 X 0.12 ) = ₹ 1,600

 Simple Interest & Compound Interest
n Simple Interest Method Compounding Interest Method
1000 + ( 1000X 10 % ) = 1,100 1000 + ( 1000X 10 % ) = 1,100
1
1100 + ( 1000X 10 % ) = 1,200 1100 + ( 1100X 10 % ) = 1,210
2 1200 + ( 1000X 10 % ) = 1,300 1210 + ( 1210X 10 % ) = 1,331
3 1300 + ( 1000X 10 % ) = 1,400 1331 + ( 1331X 10 % ) = 1,464
4 1400 + ( 1000X 10 % ) = 1,500 1464 + ( 1464X 10 % ) = 1,610
5
10900 + (1000X10%) = 11,000 1,25,27,829 + (12527829X10%)
100
= 1,37,80,612

n* No of Years
 Simple Interest & Compound Interest

Basic Valuation Techniques

Compounding Discounting
or or
Future Value Techniques Present Value Techniques

FV = PV (1 + r) n PV = FV / (1 + r) n
 Simple Interest & Compound Interest
Compounding / Future Value Techniques
1.Future Value of Single Cash flow
FVn=PV(1+r) n
2.Future Value of Uneven Cash flow
FV=R1(1+r)1 + R2(1+r)2 + R3(1+r)3…. ……+ Rn (1+r)n
3.Future Value of Annuity / Series of Equal Cash flow
FVAn=A (1+r) n – 1 Growing Annuity FV(A)= A (1+i) n – (1+g) n
r i-g
4.Future Value of Multiple Flows
FV (₹1,000)+ FV (₹2,000)+ FV (₹3,000)
= 1,000XFVF(12,3)+2,000XFVF(12,2)+3,000XFVF(12,1)
 Future Value of a Single Cashflow
Some Example # 01 : Calculation of FV of ₹ 1,000 at 10% after 7 years
Solution : FV = PV ( 1 + r )n
FV = 1000 ( 1 + 0.10 )7 = 1000 ( 1.10 )7 = 1,000 x 1.95 = ₹ 1,950
Some Example # 02 : Calculation of FV of ₹ 5,000 at 11% after 9 years
Solution : FV = PV ( 1 + r )n
FV = 5,000 ( 1 + 0.11 )9 = 5000 ( 1.11 )9 = 5,000 x 2.56 = ₹ 12,800
Some Example # 03 : Calculation of FV of ₹ 50,000 at 16% after 3 years
Solution : FV = PV ( 1 + r )n
FV = 50,000 ( 1 + 0.16 )3 = 50000 ( 1.16 )3 = 50,000 x 1.56 = ₹ 78,000
 Future Value of a Single Cashflow
Example # 02 : You are required to find out the amount to be received
By Govind after 8 years from the following data:
i) Govind has a deposit of ₹ 10,000 in a bank
ii) The bank pays 8% interest compounding annually for 8 Years

Solution : FVn = PV ( 1 + r ) n
Where,
Future Value (FV) = ?
Present Value (PV) = 10,000
% Rate of interest ( r ) = 8%
Time gap after which FV is to be ascertained ( n ) = 8 Years

FVn = 10,000 ( 1 + 0.8 ) 8 = ₹ 10,000 ( 1.8509 ) = ₹ 18,509

 Future Value of Uneven Cashflow
Example # 03 : Calculate the future value of the income stream from
The following data
i) Mr. A is planning to save some money to purchase a car and plans to
Deposit the following cashflow stream each year:
Year 1 2 3 4
₹ 1,500 3,000 2,200 3,000
ii) Interest rate is 9% for 4 Years compounded semi annually.
Solution : FV=R1(1+r)1 + R2(1+r)2 + R3(1+r)3+ R4 (1+r)4
Where,
Future Value (FV) = ?
Payment per compounding period (R1) = ₹1,500
Payment per compounding period (R2) = ₹3,000
Payment per compounding period (R3) = ₹2,200
Payment per compounding period (R4) = ₹3,000
Interest rate per compounding periods ( r ) = 0.09/2=0.045
Time gap after which FV is to be ascertained ( n ) = 4 years
 Future Value of Uneven Cashflow
n = 10 1 2 3 4

₹ 1,500 ₹ 3,000 ₹ 2,200 ₹ 3,000

FV =₹ 1,500 ( 1 + 0.045)8+ ₹ 3,000 ( 1 + 0.045)6+ ₹ 2,200 ( 1 + 0.045)4+ ₹ 3,000 ( 1 + 0.045)2

FV =₹ 1,500 ( 1.4221) + ₹ 3,000 ( 1.3023) + ₹ 2,200 ( 1.19255)+ ₹ 3,000 ( 1.0920)

FV =₹ 2,133.15 + ₹ 3,906.9 + ₹ 2,623.5 + ₹ 3,276

FV =₹ 11,939.55
Future Value of Annuity/Series of Equal Cashflows
Example # 04 : Calculate the future value of annuity at the end of five years
From the following data:
i) Deposition of 10,000 in five equal annual payments in the FD
ii) Interest rate per year is 10%
Solution: FVAn= A (1+r) n – 1
r
Where, Future value of an annuity which has time period of a years (FVAn) = ?
Constant periodic flow (A) = 10,000
Interest rate per period ( r ) = 10%
Time period of the annuity (n) = 5 years

FVAn=10,000 (1+0.10) 5 – 1 FVAn=10,000 (1.10) 5 – 1 =10000 1.611-1

0.10 0.10 0.10

= ₹ 10,000 {6.11} = ₹ 61,100

 Growing Annuity
A Finite series of regular cashflow growing at fixed rate every year is referred as growing annuity. Following is
the general formula which may be applied to calculate “Growing Annuity”

Where i <or> g:

FV (A ) = A. ( 1+i)n - ( 1 + g)n FV (A ) = A.n ( 1+i)n-1

i-g
Where,

FV (A ) = The value of the annuity at time = n,

A = The value of the individual payments in each compounding period

I = The interest rate that would be compounded for each period of time,

n = The number of payment periods,

g = Growth rate
 Growing Annuity
Example 5 : Calculate the investor’s investment at the end of 15 years from the following data:
i) Annual Salary is ₹ 5 lac.
ii) Salary increases by 5% every year
iii) Investment at 20% of the salary every year in a SIP
iv) Rate of return on SIP is 12% (*Systematic Investment Plan)
v) Investment in SIP is for 15 Years

Solution : FV (A ) = A. ( 1+i)n - ( 1 + g)n

i-g
Where, The Value of the annuity at time FV (A) = ?
Value of the individual payments in each compounding period (A) = ₹10,000
The interest rate that would be compounded for each period of time (i) = .12
The number of payment periods (n) = 15 years
Growth rate (g) = 5% or .05
Investment amount is 20% of ₹ 5 Lac = ₹ 1,00,000

(1 + .12 )15 - (1 + .05)15 5.473 – 2.078

FV(A)
= = 1,00,000 X =1,00,000 X = ₹ 48,50,000
.12 - . 05 .07
 Future Value of Multiple Flows
Example 6 : Calculate the compound value at the end of the 5th year from the following data:

i) Alok made an investment of ₹ 500, ₹ 1,000, ₹ 1,500, ₹ 2,000 and ₹ 2,500 at the end of each year.
ii) The cashflows to accumulate at the end of year 5.
iii) The interest rate 5% is compounded annually on the investment

Solution : FV (₹ 500) + FV (₹ 1,000) + FV (₹ 1,500) + FV (₹ 2,000) + FV (₹ 2,500)

= 500 X FVF(5,4) + 1,000 X FVF(5,3) + 1,500 X FVF(5,2) + 2,000 X FVF(5,1) +2,500XFVF(5,0)

= [(500 X 1.216) + ( 1,000 X 1.158) + (1,500 X 1.103) + (2,000 X 1.050) + (2,500X 1.000)

= ₹ 8,020.50
 Discounting / Present Value Techniques

Formula : PV = FV / ( I + r ) n

Where,
PV = Present Value
FV = Future Value (given)
r = % Rate of interest, and
n = No. of years for which discounting is done

Present Value Concept :

1. Present Value of Single Cashflow
2. Present Value of Uneven Cashflow Streams
3. Present Value of Annuity / Series of Equal Future Cashflows
4. Growing Annuity
5. Present Value of Perpetuity
6. Concept of Annuity Due
 Present Value Concept :
1. Present Value of Single Cashflow

Example # 07 : Calculate the present value from the following data :

i) A person will receive ₹ 3,000 after 8 years
ii) The discount rate is 10%
n
Solution : PV = FVn 1
1+r

Where,
Present Value (PV) = ?
Future Value n years (FVn) = ₹ 3,000
No. of years for which discounting is done (n) = 8 years

8
PV = 3,000 1 = 3000 ( .46651)
1+ .10

= ₹ 1,399.53 or ₹ 1400
 Present Value Concept :
2.Present Value of Uneven Cashflow Streams
Example # 08 : Calculate the present value of the following cashflow stream from the
Following data : Period 1 2 3 4
% 3 4 5.5 5
₹ 1,500 3,000 2,200 3,000
Where,
Present Value (PV) = ?
Payment per compounding period (R1) = ₹1,500
Payment per compounding period (R2) = ₹3,000
Payment per compounding period (R3) = ₹2,200
Payment per compounding period (R4) = ₹3,000
Interest rate per compounding periods (r1 ) = 0.03
Interest rate per compounding periods (r2 ) = 0.04
Interest rate per compounding periods (r3 ) = 0.055
Interest rate per compounding periods (r4 ) = 0.05
 Present Value Concept :
2.Present Value of Uneven Cashflow Streams
Example # 08 : Calculate the present value of the following cashflow stream from the
Following data : Period 1 2 3 4
% 3 4 5.5 5
₹ 1,500 3,000 2,200 3,000
Where,
Present Value (PV) = ?
Payment per compounding period (R1) = ₹1,500
Payment per compounding period (R2) = ₹3,000
Payment per compounding period (R3) = ₹2,200
Payment per compounding period (R4) = ₹3,000
Interest rate per compounding periods (r1 ) = 0.03
Interest rate per compounding periods (r2 ) = 0.04
Interest rate per compounding periods (r3 ) = 0.055
Interest rate per compounding periods (r4 ) = 0.05
 Present Value Concept :
2.Present Value of Uneven Cashflow Streams

n = 10 1 2 3 4

₹ 1,500 ₹ 3,000 ₹ 2,200 ₹ 3,000

3% 4% 5.5% 5%

PV = ₹ 1,500 ₹ 3,000 ₹ 2,200 ₹ 3,000

+ + +
( 1 + 0.03)1 ( 1 + 0.04)2 ( 1 + 0.055)3 ( 1 + 0.05)4

PV = ₹ 1,456.31 + ₹ 2,773.67 + ₹ 1,873.55 + ₹ 2,468.11

PV =₹ 8,571.64
 Present Value Concept :
3.Present Value of Annuity / Series of Equal Future Cashflows

Example # 09 : Calculate the present value from the following data :

i) Amount of Annuity is ₹ 50,000
ii) Discount rate is 8%
iii) Annuity duration is 5 years

Solution PVAn = A (1+r)n – 1

r(1+r)n

Where,
Present Value of annuity which has duration of n years (PVAn)= ?
Constant periodic flow (A) = ₹ 50,000
Discount rate ( r ) = 8%
No. of years for which discounting is done ( n) = 5 years
 Present Value Concept :
3.Present Value of Annuity / Series of Equal Future Cashflows

PVAn = ₹ 50,000 (1+0.08)5 – 1

0.08(1+0.08)5

PVAn = ₹ 50,000 (1.08)5 – 1 PVAn = ₹ 50,000 1.4693 – 1

0.08(1.08)5 0.08 x 1.4693

PVAn = ₹ 50,000 0.4693

0.1175

PVAn = ₹ 50,000 [3.995]

= ₹ 1,99,750
 Present Value Concept :
5. Present Value of Perpetuity

Example # 10 : Calculate the PV of the scheme from the following data:

i) A Person opens a recurring deposit account for a period of 10 years earning 12% interest
ii) The Scheme is accepted under the two conditions that
a) For the first year the deposit is ₹ 3,150
b) For subsequent years the deposit amount will increase by 5% every year
Solution : The present value of this scheme of deposit may be ascertained by using the
Following equation:

PV = CF1 (1+g) n
1-
r-g (1+r)
Where,
Cash Flow at the end of the period 1 (CF1) = ₹ 3,150
Rate of Interest ( r ) = 12%
Growth rate (g) = 5 %
Life of annuity ( n ) = 10 years
 Present Value Concept :
5. Present Value of Perpetuity

CF1 (1+g) n
PV = 1-
r-g (1+r)

₹ 3,150 (1+.05) 10
PV = 1-
.12- .05 (1+.12)

PV= ₹ 45,000 [ 1 – ( .937 ) 10 ]

PV= ₹ 45,000 ( .4783 )

PV= ₹ 21,524
 Present Value Concept :
5. Present Value of Perpetuity

Example # 11 : Calculate the present value of perpetuity from the following data:
i) An investment gives an expected return of ₹ 2,500 p.a
ii) The rate of interest is 12% p.a

Solution PVp = Annual Cash Flow/r

Where,
Present Value of perpetuity (PVp) =?
Annual Cash Flow = ₹ 2,500
Rate of interest (r) = 12 %

PVp = ₹ 2,500 / .12 = ₹ 2,083.33

 Present Value Concept :
6. Concept of Annuity Due
Example # 12 :Calculate the actual amount deposited by the person fro the following data:
i) A person deposited some amount at the beginning of each year for 10 years in order
to provide a sum of ₹50,000 at the end of 10 years
ii) The interest rate is 10% p.a
A[(1+ .1)10 -1
50,000 = X (1+ .1)
A [ (1 +r)-1]
Solution FV = X (1+r) .1
r
Where, 50,000 = A[(2.59-1) X (1.1)
Annuity Amount ( A ) = ? .1
Future Value (FV) = ₹50,000
Rate of interest ( r ) = 10%
Life of annuity (n) = 10 years 50,000= A 1.59 X 0.11
50,000
A= = ₹2,85,878
0.1749
 Present Value Concept :
6. Concept of Annuity Due
Example # 13 :Calculate the PV from the following data :
i) Starting from now if ₹ 1,000 is receivable in the beginning of next 4 years
ii) The rate of interest is 6%

Solution : PV = Annuity Amount X PVAF (r,n) X ( 1 + r)

Where,
Present Value ( PV ) = ?
Annuity Amount (A) = ₹ 1,000
Rate of interest ( r ) = 6 %
Life of annuity (n) = 4 years

PV = ₹ 1,000 ( 3.465) (1+ .06) = ₹ 3,673