THE TIME VALUE OF MONEY

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Introduction – FV, PV, r
• Suppose you invest Rs 1000 for three years in a savings account that pays
10% interest per year.
• What will be the amount at the end of first year?
Calculation of amount of interest - 1000 * (r = 10%) = 100
Amount at the end of first year (FV) – Rs 1000 + Rs 100
Future value (FV) = PV (1+r)
Present Value (PV) = 1000
Interest rate (r) = 10%
FV = 1100
 Compounding (Amount at the end of 3rd year)
Rs
First year: Principal at the beginning 1,000
Interest for the year
(Rs.1,000 x 0.10) 100
Principal at the end 1,100

Second year: Principal at the beginning 1,100

Interest for the year
(Rs.1,100 x 0.10) 110
Principal at the end 1,210

Third year: Principal at the beginning 1,210

Interest for the year
(Rs.1,210 x 0.10) 121
Principal at the end 1,331

FORMULA
FUTURE VALUE = PRESENT VALUE (1+r)n

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Compound or Future Value
If you invest Rs. 1000 today for 10 years at 10% in SBI, how much SBI
will give you at the end of the period?

FV = PV (1+r)n

= 1000 * 1.1010

= 2593.75

Excel Function: =FV(10%,10,0,-1000)

Help for an excel function: Formulas →Insert function → Name of the

function →Help
Simple interest and Compound interest
Compound interest is when you reinvest the interest earned for further
interest in future period.
Simple interest is when no interest is earned on the interest of the
investment
Can you calculate the value at the end of 3rd year with simple interest?
Formula = FV = PV(1+nr)
Power of compounding
Future value of Re 1
900.00

800.00

700.00
Future Value (Rs.)

600.00

5%
500.00
10%
15%
20%
400.00
25%

300.00

200.00

100.00

0.00
1 2 3 4 5 10 15 20 25 30

Years/Period
 VALUE OF FVIFr,n FOR VARIOUS
COMBINATIONS OF r AND n

n/r 6% 8% 10 % 12 % 14 %
2 1.124 1.166 1.210 1.254 1.300
4 1.262 1.361 1.464 1.574 1.689
6 1.419 1.587 1.772 1.974 2.195
8 1.594 1.851 2.144 2.476 2.853
10 1.791 2.518 2.594 3.106 3.707

FVIFr,n is Future Value Interest Factor for interest rate r and

number of years n

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Questions
1. If you invest Rs. 5000 today at 9% what will be its future value after
75 years.
Ans. 32,05,685.1
Excel function- FV
 DOUBLING PERIOD
Thumb Rule : Rule of 72
Doubling period = 72
Interest rate
Interest rate : 15 percent
Doubling period = 72 = 4.8 years
15
A more accurate thumb rule : Rule of 69
69
Doubling period = 0.35 +
Interest rate
Interest rate : 15 percent
69
Doubling period = 0.35 + = 4.95 years
15
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Questions
Question 1 If the interest rate is 14%, how many years would it take for
your money double?
Answer: 5.14 (Rule of 72) & 5.27 (Rule of 69)
Question 2: If the interest rate is 12%, how many years would it take for
your money double?
Answer: 6.1 (Rule of 69)
 SHORTER COMPOUNDING PERIOD

Future value = Present value 1+ r mxn

m
Where r = nominal annual interest rate
m = number of times compounding is done in a
year
n = number of years over which compounding is
done
Example : Rs.5000, 12 percent, 4 times a year, 6 years
5000(1+ 0.12/4)4x6 = 5000 (1.03)24
= Rs.10,164

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Effective Annual Rate and Annual Percentage Rate (APR)

r = (1+k/m)m –1
r = effective annual rate (EAR)
k = annual percentage rate (APR)
m = frequency of compounding per year
Example : k = 8 percent, m=4
r = (1+.08/4)4 – 1 = 0.0824
= 8.24 percent
APR (Nominal Rate) and EAR
Effective Rate %
Nominal Annual Semi-annual Quarterly Monthly
Rate % Compounding Compounding Compounding Compounding
8 8.00 8.16 8.24 8.30
12 12.00 12.36 12.55 12.68

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Questions
1) If you invest Rs. 5000 today at 9% what will be its future value after 75
years.
2) I have deposited Rs. 1000 in a bank account at 12% p.a. How long will it
take to accumulate to Rs. 2000.
3) Suppose Annual Percentage Rate (APR) is 12% and bank is providing
interest quarterly then what is the effective rate of interest?
4) Suppose you have deposited Rs 1000 in SBI at an interest rate 12% p.a.,
SBI pays interest every month, what will be the amount at the end of
two years.
Ans(1) - 32,05,685.1
And(2)- 6 years or 6.1 years (Use the doubling formulas – rule 69 and 72)
Ans(3)- 12.55%
Ans(4)- 1270
Formulas and terminologies for
calculating Future Values – Single Amt
 PRESENT VALUE OF A SINGLE AMOUNT

PV = FVn [1/ (1 + r)n]

n/r 6% 8% 10% 12% 14%

2 0.890 0.857 0.826 0.797 0.770
4 0.792 0.735 0.683 0.636 0.592
6 0.705 0.630 0.565 0.507 0.456
8 0.626 0.540 0.467 0.404 0.351
10 0.558 0.463 0.386 0.322 0.270
12 0.497 0.397 0.319 0.257 0.208

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Questions
Q1 What is the present value of 1,000,000 receivable 60 years from now, if the
discount rate is 10 per cent?
Q2 Someone promises to give you 5000 after 10 years in exchange of 1000
today. What interest rate is implicit in this offer?
Q3 A bank offers an interest rate of 8 per cent on deposits made with it. If the
compounding is done on a weekly basis, what is the effective rate of interest?
Q4 As a winner of a competition, you can choose one of the following prizes:
A) 500,000 now
B) 1,000,000 at the end of 6 years
Which one would you choose?
Q5 You have a choice between 5000 now and 20000 after 10 years. Which
would you choose? What does the preference indicate?
Opportunity Cost
Would you rather
◦ Watch Never have I ever on Netflix
◦ Study for FM-1

Would you rather

◦ Save 10 Lakhs today
◦ Buy a car

Opportunity cost is the forgone alternative of choosing an option

 Time Value of Money
What would you prefer
◦ Option 1: Spending ₹ 50000 today on a play station
◦ Option 2: Loaning ₹ 50000 to your sibling with a promise of pay back in an year

Reasons?
Consumption preferences: The opportunity cost of loaning money is today’s
consumption
Time value of money
One needs to be compensated for giving up on current consumption.
Therefore, A rupee today is worth more than a rupee tomorrow
meaning money has time value
Inflation: Price increase. Play station may get expensive in future
Risk: You have loaned money to your brother but there is risk that your
brother may not return the money. Need to be compensated for taking
the risk

Interest rate is the price of borrowing and lending

Future Value
FV = PV × (1+r)n
FV = PV × FVIFr,n …(FVIFr,n = (1+r)n )
FVIFr,n → Look for its value in Table A1 Compound Sum of One Rupee
Present Value
PV = FV × (1/(1+r)n )
PV = FV × PVIFr,n …(PVIFr,n = 1/(1+r)n )
PVIFr,n → Look for its value in Table A3 Present Value of One Rupee
 PRESENT VALUE OF AN UNEVEN SERIES
A1 A2 An
PVn = + + …… +
(1 + r) (1 + r)2 (1 + r)n
n At
= 
t =1 (1 + r)t

Year Cash Flow

Rs.
1 1,000
2 2,000
3 2,000
4 3,000
5 3,000
6 4,000
7 4,000
8 5,000

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 PRESENT VALUE OF AN UNEVEN SERIES
A1 A2 An
PVn = + + …… +
(1 + r) (1 + r)2 (1 + r)n
n At
= 
t =1 (1 + r)t

Year Cash Flow PVIF12%,n Present Value of

Rs. Individual Cash Flow
1 1,000 0.893 893
2 2,000 0.797 1,594
3 2,000 0.712 1,424
4 3,000 0.636 1,908
5 3,000 0.567 1,701
6 4,000 0.507 2,028
7 4,000 0.452 1,808
8 5,000 0.404 2,020

Present Value of the Cash Flow Stream 13,376

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Questions
Q1: Find the present value of the following cash flow streams. The
discount rate is 12%
Questions
Q1 If an investment is growing at the rate of 12%, then how long will it
take for INR 2020 to become INR 5000?
Q2 Someone promises to give you INR 4000 after 7 years in exchange of
INR 1800 today. What interest rate is implicit in this offer?
Annuity
Definition- Stream of equal/constant cashflow (payments or receipts)
occurring at regular intervals of time.
Example- Premium of a life insurance policy
Ordinary Annuity- Cashflows occur at the end of each period. For ex-
consistent quarterly stock dividends
Annuity Due- Cashflows occur at the beginning of each period. For ex-
House rents
 FUTURE VALUE OF AN ANNUITY

Suppose you deposit 1000 annually in a bank for 5 years and your deposits earn a compound interest
rate of 10%. What will be the value of this series at the end of 5 years?
1 2 3 4 5
1,000 1,000 1,000 1,000 1,000
+
1,100

+
1,210
+
1,331
+
1,464
Rs.6,105
• Future value of an annuity = A [(1+r)n-1]
r
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Future Value of an Annuity
Future Value of an Annuity (FVA) = A × [(1+r)n -1]/r
FVA = A × FVIFAr,n …(FVIFAr,n = [(1+r)n -1]/r)
FVIFAr,n look for its value in Table A2 The Compound Value of an
Annuity of One Rupee
Questions
Q1 Suppose you have decided to deposit Rs.30,000 per year in your
Public Provident Fund Account for 30 years. What will be the
accumulated amount in your Public Provident Fund Account at the end
of 30 years if the interest rate is 11 percent ?
Q2 You want to buy a house after 5 years when it is expected to cost INR
2 million. How much should you save annually if your savings earn a
compound return of 12 percent ?
Q3 Futura Limited has an obligation to redeem INR 500 million bonds 6
years hence. How much should the company deposit annually in a
sinking fund account wherein it earns 14 percent interest to cumulate
INR 500 million in 6 years time ?
Questions
Q4 A finance company advertises that it will pay a lump sum of Rs.8,000
at the end of 6 years to investors who deposit annually Rs.1,000 for 6
years. What interest rate is implicit in this offer?
Q5 You want to take up a trip to the moon which costs INR 1,000,000-
the cost is expected remain unchanged in nominal terms. You can save
annually INR 50,000 to fulfil your desire. How long should you wait if
your savings earn an interest rate of 12 per cent.
 WHAT LIES IN STORE FOR YOU
Suppose you have decided to deposit Rs.30,000 per year in your
Public Provident Fund Account for 30 years. What will be the
accumulated amount in your Public Provident Fund Account at
the end of 30 years if the interest rate is 11 percent ?
The accumulated sum will be :
Rs.30,000 (FVIFA11%,30yrs)
= Rs.30,000 (1.11)30 - 1
.11
= Rs.30,000 [ 199.02]
= Rs.5,970,600

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 HOW MUCH SHOULD YOU SAVE ANNUALLY
You want to buy a house after 5 years when it is expected to cost
Rs.2 million. How much should you save annually if your savings
earn a compound return of 12 percent ?

The future value interest factor for a 5 year annuity, given

an interest rate of 12 percent, is :
(1+0.12)5 - 1
FVIFA n=5, r =12% = = 6.353
0.12
The annual savings should be :
Rs.2000,000 = Rs.314,812
6.353
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 ANNUAL DEPOSIT IN A SINKING FUND
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 percent
interest to cumulate Rs.500 million in 6 years time ?
The future value interest factor for a 5 year annuity,
given an interest rate of 14 percent is :
FVIFAn=6, r=14% = (1+0.14)6 – 1 = 8.536
0.14
The annual sinking fund deposit should be :
Rs.500 million = Rs.58.575 million
8.536
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 FINDING THE INTEREST RATE
A finance company advertises that it will pay a lump sum of Rs.8,000 at the
end of 6 years to investors who deposit annually Rs.1,000 for 6 years. What
interest rate is implicit in this offer?
The interest rate may be calculated in two steps :
1. Find the FVIFAr,6 for this contract as follows :
Rs.8,000 = Rs.1,000 x FVIFAr,6
FVIFAr,6 = Rs.8,000 = 8.000
Rs.1,000
2. Look at the FVIFAr,n table and read the row corresponding to 6 years
until you find a value close to 8.000. Doing so, we find that
FVIFA12%,6 is 8.115 . So, we conclude that the interest rate is slightly below
12 percent.

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Present Value of an Annuity
Present Value of an Annuity (PVA) = A × [1-(1/(1+r))n ]/r
PVA = A × PVIFAr,n …(PVIFAr,n = [1-(1/(1+r))n ]/r)
PVIFAr,n look for its value in Table A4 Present Value of an Annuity of
One Rupee
 PRESENT VALUE OF AN ANNUITY
1- 1
Present value of an annuity = A (1+r)n
r
Value of PVIFAr,n for Various Combinations of r and n
n/r 6 % 8% 10 % 12 % 14 %
2 1.833 1.783 1.737 1.690 1.647
4 3.465 3.312 3.170 3.037 2.914
6 4.917 4.623 4.355 4.111 3.889
8 6.210 5.747 5.335 4.968 4.639
10 7.360 6.710 6.145 5.650 5.216
12 8.384 7.536 6.814 6.194 5.660

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Questions
Q1 Suppose you expect to receive INR 1000 annually for 3 years, each
receipt occurring at the end of the year. What is the present values of
this stream of benefits if the discount rate is 10 per cent?
Questions
Q1 After reviewing budget, you have determined that you can afford to
pay INR 12,000 per month for 3 years toward a new car. You call a
finance company and learn that the going rate of interest on car finance
is 1.5 per cent per month for 36 months. How much can you borrow?
Ans 331,920 [Loan payments are ordinary annuity]
Q2 Pradeep takes a housing loan of INR 30 lakhs for a period of 15 years
at an interest rate of 8% p.a. What will be the Equated Monthly
Installments (EMI)?
Ans 28,670 [Calculate per month interest rate, and count EMIs 15*12]
Q3 Your father deposits INR 300,000 on retirement in a bank which pays
10 per cent annual interest. How much can be withdrawn annually for a
period of 10 years?
Ans 48,820 [PVA is given, calculate A]
Questions
Q4 If you deposit INR 10,000 with an investment firm, it promises to
pay INR 2500 annually for 6 years. What interest rate do you earn on
this deposit?
Ans 13% [PVA = 10000, A = 2500, n = 6, r = ?]
Q5 A 12-payment annuity of INR 10,000 will begin 8 years hence. What
is the present value of this annuity if the discount rate is 14 per cent?
Ans 22,640 [Step1: Calculate the PVA for time 7, then calculate its value
at time 0]
Q6 What is the present value of cashflow stream at 14% discount rate?
Year 0 1 2 3 4
Cashflow (5,000) 6,000 8,000 9,000 8,000
Ans 17,225 [Bracket means negative; No interest earned at time 0]
Questions
Q7 You want to take a world tour which costs INR 1,000,000-the cost is
expected to remain unchanged in nominal terms. You are willing to save
annually INR 80,000 to fulfill your desire. How long will you have to wait
if your savings earn a return of 14% per annum?
Ans 7.72 years
Q8 On retirement, Mr. Jingo is given a choice between two alternatives:
a) an annual pension of INR 10,000 as long as he lives, and b) a lump
sum amount of INR 50,000. If Mr. Jingo expects to live for 15 years and
the interest rate is 15%, which option is more attractive?
Ans Option a is the correct answer
PVA = 58,470
 Questions
Q9 You can receive the compensation in the following ways. Assume
interest rate to be 10 per cent
A. 500,000 now
B. 1,000,000 at the end of 6 years
C. 100,000 per year for 10 years
D. 60,000 a year forever

i. Which option is the best? – you will choose option (c)

ii. What interest rate will make you indifferent between option A and
B? [Break-even investment, compare the PV of A and B, find r]
iii. What interest rate will make you indifferent between option A and
C?
iv. What interest rate will make you indifferent between option B and
C?
 Questions
Q10 Raghavan will receive an annuity of 50,000, payable once every two years. The payments will
stretch out over 30 years. The first payment will be received at the end of two years. If the annual
interest rate is 8 percent, what is the present value of the annuity. [Infrequent annuity]
Ans 270,620 [Calculate the compounded interest rate for 2 periods, reduce the n to no. of payments]
Q11 Ravi wants to save for the college education of his son, Deepak. Ravi estimates the college
expenses to be 1 million per year for 4 years when his son reaches college in 16 years- the expenses
will be payable at the beginning of the years. He expects the annual interest of 8 per cent over the
next two decades. How much should he deposit in the bank each year for the next 15 years to take
care of his son’s education.
Ans 121,980 [Calculate the PVA of expenses (4 years), PVA of expenses should be FVA for deposits for
Ravi to cover the cost (15 years)]
Q12 Mahesh deposits 2,00,000 in a bank account which pays 10%. How much can he withdraw
annually for a period of 15 years?
Ans 26,295 [PVA = 2,00,000; r = 10%, n= 15, A=?]
 Questions
Q13 A ltd. Has to retire 1000 million of debentures each at the end of 8,9, and 10
years from now. How much should the firm deposit in a sinking fund account annually
for 5 years, in order to retire the debentures? The net interest rate earned is 8%.
Ans 376.68 Million [Calculate the PVA (n=3,4,5) of debentures, sum of PV will be the
FVA of deposits]
Q14 Apna bank’s Kuber deposit plan offers to double your deposit in 7 years under its
daily compounding of interest scheme. What is the interest rate involved?
Ans 9.9 per cent [m = 365, n=7, FV/PV or FVIF= 2]
Q15 If you deposit 5000 today at 12 per cent rate of interest in how many years will
this amount grow to 160000? – Use rule of 72
Ans 30 years [First calculate how many times 5000 needs to double to become
160000=> 160000/5000 = 32 = (2) power (5) => calculate doubling period and multiply
by 5]
Questions
Q16 What is the present value of an income stream which provides
2000 a year for 5 years and 3000 a year forever thereafter, if the
discount rate is 10 per cent
Ans 26,212 [PVA of Annuity of 2000, n=5,r=10%; PVA of perpetuity of
3000 at 10%, convert the PVA at time 5 to PV at time 0 ]
Q17 What is the present value of an income stream which provides
1000 at the end of year one, 2500 at the end of year two, and 5000
during each years 3 through 10, if the discount rate is 12 per cent?
Ans 22,693
Questions
Q18 What amount must be deposited today in order to earn an annual
income of 5000 beginning from the end of 15 years from now? The
deposit earns 10 per cent per year.
Ans 13,165

Q19 How much should be deposited at the beginning of each year for
10 years in order to provide a sum of 50000 at the end of 10 years?
Ans 2544 [annuity due]
[Its FVA = FVIFA * (1+r) * A = 50000]
Questions
Q20 After 5 years Mr. Ramesh will receive a pension of 6000 per month
for 15 years. How much can Mr. Ramesh borrow now at 12% percent so
that the borrowed amount can be paid with 30 per cent of the pension
amount? The interest will be accumulated till the first pension amount
becomes receivable.
Ans 85,215 [Borrowing]
Solution: 30% of 6000 = 1800 => Monthly annuity of 1800 at 12% for
180 months. Its present value will be the FV of borrowed amount. Solve
for PV of borrowings at 12% annual interest rate and n=5
 Present Value of Perpetuities
Suppose an investment offers a fixed amount at the end of every period
forever (perpetual), the present value of the series of future cash flow is

C 
PV of Perpetuity =  
r 
 EQUATED MONTHLY INSTALMENT

Loan = 1,000,000, Interest = 1% p.m, Repayment period =

180 months

A x [1-1/(0.01)180]
1,000,000 =
0.01
A = Rs.12,002

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 ANNUITY DUE

A A … A A
Ordinary
annuity
0 1 2 n–1 n

A A A … A
Annuity
due
0 1 2 n–1 n

Thus,
Annuity due value = Ordinary annuity value (1 + r)
This applies to both present and future values

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PRESENT VALUE OF PERPETUITY

A
Present value of perpetuity =
r

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Use of Excel Spreadsheet Time value calculations can be
easily done using a spreadsheet. In Excel, there are
customised notations and functions for the various time
value parameters as shown below:
Parameter Notation Built in Formula in Excel
/Symbol

Present value PV =PV(rate,nper,pmt,[fv],[type])

Future value FV =FV(rate,nper,pmt,[pv],[type])
No. of continuous NPER =NPER(rate,pmt,pv,[fv],[type])
successive periods

Payment per period PMT =PMT(rate,nper,pv,[fv],[type])

 SUMMING UP
• Money has time value. A rupee today is more valuable than a
rupee a year hence.
• The general formula for the future value of a single amount
is :
Future value = Present value (1+r)n
• The value of the compounding factor, (1+r)n, depends on the
interest rate (r) and the life of the investment (n).
• According to the rule of 72, the doubling period is obtained
by dividing 72 by the interest rate.
• The general formula for the future value of a single cash
amount when compounding is done more frequently than
annually is:
Future value = Present value [1+r/m]m*n
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• An annuity is a series of periodic cash flows (payments and
receipts) of equal amounts. The future value of an annuity is:
Future value of an annuity
= Constant periodic flow [(1+r)n – 1)/r]
• The process of discounting, used for calculating the present
value, is simply the inverse of compounding. The present
value of a single amount is:
Present value = Future value x 1/(1+r)n
• The present value of an annuity is:
Present value of an annuity
= Constant periodic flow [1 – 1/ (1+r)n] /r
• A perpetuity is an annuity of infinite duration. In general
terms:
Present value of a perpetuity = Constant periodic flow [1/r]

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