Unit-3 Time Value of Money

Future Value
Unit-3
Present Value
Time Value of Future Value of annuity
Money Present value of annuity
Annuity Due
Uneven cash flows streams
Perpetuities
Amortization of loans
Future Value
• Rupee you have could be invested, earn interest and end up
with more than a rupee in future.
• The amount to which a cash flow or series of cash flows will
grow over a given period of time when compounded at a
given interest rate.
• The process of going from present value to future value is
called compounding.
• Compound Interest Occurs when interest is earned on prior
periods’ interest.
Time Value of Money
 Value of money does not remain same through out the time
 A rupee today is worth more than a rupee tomorrow
 Time value of money has many applications….
• Planning for Retirement
• Valuing of Bond & Stocks
• Setting up loan payment schedules
• Making corporate decisions regarding investing in new
equipment and plants…etc.
Future value
Future value of $100 = $100 × (1 + r) ^t : {FV =PV × (1+r)^t}
PV =Present value, or beginning amount.
FVN = Future value, or ending amount, of your account after N periods.

r= Interest rate or Rate of return
t= Number of periods involved
For example, by the end of 20 years, $100 invested at 10% will grow
to $100 × (1.10)^20 = $672.75.
Present value - meaning
• A rupee paid to you one year from now is less valuable
than a rupee paid to you today.
• Present value of Rs 1 is the minimum number of rupees that
you would have to give up today in return for receiving Rs 1
in year n.
• Why?
– impatient
– forgone interest
5
Present Value
 It is the reverse process of finding future value.
 We have seen that $100 invested for two years at 10 % will grow to a future value
of 100 × (1.10)^20 = $672.75.
 Let’s turn this around and ask how much you need to invest today to produce
$672.75 at the end of 20 years.
PV= $672.75/ (1.10)^20
PV =100
 {FV =PV × (1+r)^t}

FV/ (1+r)^t= PV
:. PV= FV/(1+r)^t
Present value
– discounting a future cash flow
• PV= Present Value/Today’s Value
• i= the interest rate/discount rate
• CF= Cash Flows
• N= years involved
PV = CF / (1+i)^n or CF * 1/(1+i)^n
The Expression 1/(1+i)^n is called discount factor.

PV for Multiple Period Cashflows
• Suppose that you wish to value a stream of cash flows extending over a number of
years.
Our rule for adding present values tells us that the total present value is:
PV = C1/(1 + r)+C2 /(1 + r)2 + C3/(1 + r)3 +⋅ ⋅ ⋅ +CT/(1 + r)T
• This is called the discounted cash flow (or DCF) formula. A shorthand way to write it is
• where Σ refers to the sum of the series of discounted cash flows.

For example- The Project has cash flows coming over 4
years then calculate the total present value of future cash
flows of the project at the interest rate of 8%.
Cash Flows Discounting Discount Factor Present Values
10,000.00 1/(1+.08) 0.9259 9,259.26
20,000.00 1/(1+.08)^2 0.8573 17,146.78
30,000.00 1/(1+.08)^3 0.7938 23,814.97
40,000.00 1/(1+.08)^4 0.7350 29,401.19
Total Present Value 79,622.20
Annuity
• An annuity is an asset that pays a fixed sum each year for
a specified number of years.
• A series of equal payments at fixed intervals for a specified
number of periods.
• Auto, student, and mortgage loans, require a series of
payments. When the payments are equal and are made at
fixed intervals, the series is an annuity.
• For example, $100 paid at the end of each of the next 3
years is a 3-year annuity.
If the payments occur at the end of each year, the annuity is an
ordinary (or deferred) annuity.
If the payments are made at the beginning of each year, the
annuity is an annuity due.
Present value of an Annuity
• The present value of an annuity is the current value of future

payments from an annuity, given a specified rate of return, or
discount rate.
• The higher the discount rate, the lower the present value of the
annuity.
• The present value of an annuity refers to how much money would
be needed today to fund a series of future annuity payments
Present value of an Annuity( Ordinary)
Present Value of Ordinary Annuity
We Can calculate Present Value of annuity by simply using a annuity formula;
O OO OR,
PVAN /
Where as,
P= Present Value of Annuity
PMT/ C = Amount of annuity Payment
R/I = Interest Rate Or Discount rate
T/N= Number of Periods ( eg. Years)
Suppose that Auto Company offers an “easy payment” scheme on a new Toyota of $5,000 a year, paid at the end of
each of the next five years, with no cash down at interest rate of 7% , What is the car really costing you?
Present Value of Annuity Due
With an annuity due, in which payments are made at the beginning of each
period, the formula is slightly different. To find the value of an annuity due,
simply multiply the ordinary annuity formula by a factor of (1 + r).
Or,
PV of Annuity Due = Present Value of Ordinary Annuity * (1+r)
Future Value of an Annuity
The future value of an annuity is a way of calculating how much money a
series of payments will be worth at a certain point in the future.
FVAN /
Future Value of an Annuity Due
To find the value of an annuity due, simply multiply the ordinary annuity
formula by a factor of (1 + r).
FVAN /
Or,
FV of Annuity Due = Future Value of Ordinary Annuity * (1+r)
Uneven Cashflows
• A series of cash flows where the amount varies from one period to the
next.
• There are two important classes of uneven cash flows:
(1) a stream that consists of a series of annuity payments plus an additional
final lump sum and
(2) All other uneven streams

Present Values of an Uneven Cash Flows
Future Value of an Uneven Cash Flows
Perpetuities
• A perpetuity is a security that pays for an infinite amount of time.
In finance, perpetuity is a constant stream of identical cash flows
with no end.
• The stream of cash flows continues for an infinite amount of time
• A perpetuity is simply an annuity with an extended life.
• A stream of equal payments at fixed intervals expected to
continue forever.
CONSOL
• A perpetual bond issued by the British government
to consolidate past debts; in general, any perpetual bond.
Present Value of Perpetuities
PV= PMT/ I
Or,
PV = C/r
where:
PV=present value
C/PMT=cash flow/Payment
r/i=discount rate/Interest Rate

For Example :
You aim to provide $1 billion a year in perpetuity, starting next
year. So, if the interest rate is 10%, you need to write a check
today for;
Loan Amortization
Bank loans are paid off in equal installments. Suppose that you take out a
four-year loan of $1,000. The bank requires you to repay the loan evenly
over the four years. It must therefore set the four annual payments so
that they have a present value of $1,000.

Unit-3 Time Value of Money

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Future Value

FVN = Future value, or ending amount, of your account after N periods.

 {FV =PV × (1+r)^t}

The Expression 1/(1+i)^n is called discount factor.

• where Σ refers to the sum of the series of discounted cash flows.

• The present value of an annuity is the current value of future

(2) All other uneven streams

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