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Chapter 6

TIME VALUE OF MONEY


1.

2.

Value five years hence of a deposit of Rs.1,000 at various interest rates is as


follows:
r

8%

FV5

=
=

1000 x FVIF (8%, 5 years)


1000 x 1.469 =
Rs.1469

10%

FV5

=
=

1000 x FVIF (10%, 5 years)


1000 x 1.611 =
Rs.1611

12%

FV5

=
=

1000 x FVIF (12%, 5 years)


1000 x 1.762 =
Rs.1762

15%

FV5

=
=

1000 x FVIF (15%, 5 years)


1000 x 2.011 =
Rs.2011

Rs.160,000 / Rs. 5,000 = 32 = 25


According to the Rule of 72 at 12 percent interest rate doubling takes place
approximately in 72 / 12 = 6 years
So Rs.5000 will grow to Rs.160,000 in approximately 5 x 6 years = 30 years

3.
In 12 years Rs.1000 grows to Rs.8000 or 8 times. This is 2 3 times the initial
deposit. Hence
doubling takes place in 12 / 3 = 4 years.
According to the Rule of 69, the doubling period is:
0.35 + 69 / Interest rate
Equating this to 4 and solving for interest rate, we get
Interest rate = 18.9%.
4.

Saving Rs.2000 a year for 5 years and Rs.3000 a year for 10 years thereafter is
equivalent to saving Rs.2000 a year for 15 years and Rs.1000 a year for the years
6 through 15.
Hence the savings will cumulate to:
2000 x FVIFA (10%, 15 years) + 1000 x FVIFA (10%, 10 years)
=
2000 x 31.772 + 1000 x 15.937
=
Rs.79481.

5.

Let A be the annual savings.

6.

A x FVIFA (12%, 10 years) =


A x 17.549
=

1,000,000
1,000,000

So, A = 1,000,000 / 17.549 =

Rs.56,983.

1,000 x FVIFA (r, 6 years)

10,000

FVIFA (r, 6 years)

10,000 / 1000 = 10

=
=

9.930
10.980

From the tables we find that


FVIFA (20%, 6 years)
FVIFA (24%, 6 years)

Using linear interpolation in the interval, we get:


20% + (10.000 9.930)
r=

x 4% = 20.3%
(10.980 9.930)

7.

1,000 x FVIF (r, 10 years)


FVIF (r,10 years)

=
=

5,000
5,000 / 1000 = 5

From the tables we find that


FVIF (16%, 10 years) =
FVIF (18%, 10 years) =

4.411
5.234

Using linear interpolation in the interval, we get:


(5.000 4.411) x 2%
r = 16% +

= 17.4%
(5.234 4.411)

8.

9.

The present value of Rs.10,000 receivable after 8 years for various discount rates
(r ) are:
r = 10%
PV
= 10,000 x PVIF(r = 10%, 8 years)
= 10,000 x 0.467 = Rs.4,670
r = 12%

PV

= 10,000 x PVIF (r = 12%, 8 years)


= 10,000 x 0.404 = Rs.4,040

r = 15%

PV

= 10,000 x PVIF (r = 15%, 8 years)


= 10,000 x 0.327 = Rs.3,270

Assuming that it is an ordinary annuity, the present value is:

2,000 x PVIFA (10%, 5years)


= 2,000 x 3.791 = Rs.7,582
10.

The present value of an annual pension of Rs.10,000 for 15 years when r = 15%
is:
10,000 x PVIFA (15%, 15 years)
= 10,000 x 5.847 = Rs.58,470
The alternative is to receive a lumpsum of Rs.50,000.
Obviously, Mr. Jingo will be better off with the annual pension amount of
Rs.10,000.

11.

The amount that can be withdrawn annually is:


100,000
100,000
A = ------------------ ------------ = ----------- = Rs.10,608
PVIFA (10%, 30 years)
9.427

12.

The present value of the income stream is:


1,000 x PVIF (12%, 1 year) + 2,500 x PVIF (12%, 2 years)
+ 5,000 x PVIFA (12%, 8 years) x PVIF(12%, 2 years)
= 1,000 x 0.893 + 2,500 x 0.797 + 5,000 x 4.968 x 0.797 = Rs.22,683.

13.

The present value of the income stream is:


2,000 x PVIFA (10%, 5 years) + 3000/0.10 x PVIF (10%, 5 years)
= 2,000 x 3.791 + 3000/0.10 x 0.621
= Rs.26,212

14.

To earn an annual income of Rs.5,000 beginning from the end of 15 years from
now, if the deposit earns 10% per year a sum of
Rs.5,000 / 0.10 = Rs.50,000
is required at the end of 14 years. The amount that must be deposited to get this
sum is:
Rs.50,000 / FVIF (10%, 14 years) = Rs.50,000 / 3.797 = Rs.13,165

15.

Rs.20,000 =- Rs.4,000 x PVIFA (r, 10 years)


PVIFA (r,10 years) = Rs.20,000 / Rs.4,000 = 5.00
From the tables we find that:
PVIFA (15%, 10 years)
PVIFA (18%, 10 years)

=
=

5.019
4.494

Using linear interpolation we get:


5.019 5.00
r = 15% +
---------------5.019 4.494

x 3%

= 15.1%
16.

PV (Stream A) = Rs.100 x PVIF (12%, 1 year) + Rs.200 x


PVIF (12%, 2 years) + Rs.300 x PVIF(12%, 3 years) + Rs.400 x
PVIF (12%, 4 years) + Rs.500 x PVIF (12%, 5 years) +
Rs.600 x PVIF (12%, 6 years) + Rs.700 x PVIF (12%, 7 years) +
Rs.800 x PVIF (12%, 8 years) + Rs.900 x PVIF (12%, 9 years) +
Rs.1,000 x PVIF (12%, 10 years)
= Rs.100 x 0.893 + Rs.200 x 0.797 + Rs.300 x 0.712
+ Rs.400 x 0.636 + Rs.500 x 0.567 + Rs.600 x 0.507
+ Rs.700 x 0.452 + Rs.800 x 0.404 + Rs.900 x 0.361
+ Rs.1,000 x 0.322
= Rs.2590.9
Similarly,
PV (Stream B) = Rs.3,625.2
PV (Stream C) = Rs.2,851.1

17.

FV5

=
=
=
=

Rs.10,000 [1 + (0.16 / 4)]5x4


Rs.10,000 (1.04)20
Rs.10,000 x 2.191
Rs.21,910

18.

FV5

=
=
=
=

Rs.5,000 [1+( 0.12/4)] 5x4


Rs.5,000 (1.03)20
Rs.5,000 x 1.806
Rs.9,030

19

Stated rate (%)

12

Frequency of compounding 6 times

4 times

24
12 times

(1 + 0.12/6)6- 1 (1+0.24/4)4 1 (1 + 0.24/12)12-1

Effective rate (%)

Difference between the


effective rate and stated
rate (%)
20.

24

= 12.6

= 26.2

= 26.8

0.6

2.2

2.8

Investment required at the end of 8th year to yield an income of Rs.12,000 per
year from the end of 9th year (beginning of 10th year) for ever:
Rs.12,000 x PVIFA(12%, )
= Rs.12,000 / 0.12 = Rs.100,000
To have a sum of Rs.100,000 at the end of 8 th year , the amount to be deposited
now is:
Rs.100,000
Rs.100,000
=
= Rs.40,388
PVIF(12%, 8 years)
2.476

21.

The interest rate implicit in the offer of Rs.20,000 after 10 years in lieu of
Rs.5,000 now is:
Rs.5,000 x FVIF (r,10 years) = Rs.20,000
Rs.20,000
FVIF (r,10 years) =

= 4.000
Rs.5,000

From the tables we find that


FVIF (15%, 10 years) = 4.046
This means that the implied interest rate is nearly 15%.
I would choose Rs.20,000 after 10 years from now because I find a return of 15%
quite acceptable.

22.

FV10

= Rs.10,000 [1 + (0.10 / 2)]10x2


= Rs.10,000 (1.05)20
= Rs.10,000 x 2.653
= Rs.26,530

If the inflation rate is 8% per year, the value of Rs.26,530 10 years from now, in
terms of
the current rupees is:
Rs.26,530 x PVIF (8%,10 years)
= Rs.26,530 x 0.463 = Rs.12,283
23.

A constant deposit at the beginning of each year represents an annuity due.


PVIFA of an annuity due is equal to : PVIFA of an ordinary annuity x (1 + r)
To provide a sum of Rs.50,000 at the end of 10 years the annual deposit should
be
A

Rs.50,000
FVIFA(12%, 10 years) x (1.12)
Rs.50,000

= Rs.2544
17.549 x 1.12

24.

The discounted value of Rs.20,000 receivable at the beginning of each year from
2025 to 2029, evaluated as at the beginning of 2024 (or end of 2023) is:
Rs.20,000 x PVIFA (12%, 5 years)
=
Rs.20,000 x 3.605 = Rs.72,100.
The discounted value of Rs.72,100 evaluated at the end of 2020 is
Rs.72,100 x PVIF (12%, 3 years)
=
Rs.72,100 x 0.712 = Rs.51,335
If A is the amount deposited at the end of each year from 2015 to 2020 then
A x FVIFA (12%, 6 years) = Rs.51,335
A x 8.115 = Rs.51,335
A = Rs.51,335 / 8.115
=
Rs.6326

25.

26.

The discounted value of the annuity of Rs.2000 receivable for 30 years, evaluated
as at the end of 9th year is:
Rs.2,000 x PVIFA (10%, 30 years) = Rs.2,000 x 9.427 = Rs.18,854
The present value of Rs.18,854 is:
Rs.18,854 x PVIF (10%, 9 years)
=
Rs.18,854 x 0.424
=
Rs.7,994
30 per cent of the pension amount is

0.30 x Rs.6000 = Rs.1800


Assuming that the monthly interest rate corresponding to an annual interest rate of
12% is 1%, the discounted value of an annuity of Rs.1800 receivable at the end of each
month for 180 months (15 years) is:
Rs.1800 x PVIFA (1%, 180)
(1.01)180 - 1
Rs.1800 x
---------------- = Rs.149,980
.01 (1.01)180
If Mr. Ramesh borrows Rs.P today on which the monthly interest rate is 1%
P x (1.01)60 =
P x 1.817
=
P
27.

Rs.149,980
Rs.149,980
Rs.149,980
------------ = Rs.82,540
1.817

Rs.3000 x PVIFA(r, 24 months) = Rs.60,000


PVIFA (r,24) =
Rs.60000 / Rs.3000 = 20
From the tables we find that:
PVIFA(1%,24)
=
PVIFA (2%, 24)
=

21.244
18.914

Using a linear interpolation


21.244 20.000
r = 1% +
---------------------21.244 18,914

x 1%

= 1.53%
Thus, the bank charges an interest rate of 1.53% per month.
The corresponding effective rate of interest per annum is
[ (1.0153)12 1 ] x 100 = 20%
28.

The discounted value of the debentures to be redeemed between 8 to 10 years


evaluated at the end of the 5th year is:
Rs.10 million x PVIF (8%, 3 years)
+ Rs.10 million x PVIF (8%, 4 years)
+ Rs.10 million x PVIF (8%, 5 years)
= Rs.10 million (0.794 + 0.735 + 0.681)
= Rs.2.21 million

If A is the annual deposit to be made in the sinking fund for the years 1 to 5,
then
A x FVIFA (8%, 5 years) = Rs.2.21 million
A x 5.867 = Rs.2.21 million
A = 5.867 = Rs.2.21 million
A = Rs.2.21 million / 5.867 = Rs.0.377 million
29.

Let `n be the number of years for which a sum of Rs.20,000 can be withdrawn
annually.
Rs.20,000 x PVIFA (10%, n) = Rs.100,000
PVIFA (10 %, n) = Rs.100,000 / Rs.20,000 = 5.000
From the tables we find that
PVIFA (10%, 7 years) =
PVIFA (10%, 8 years) =

4.868
5.335

Thus n is between 7 and 8. Using a linear interpolation we get


n=7+
30.

5.000 4.868
----------------5.335 4.868

Equated annual installment

x 1 = 7.3 years

= 500000 / PVIFA(14%,4)
= 500000 / 2.914
= Rs.171,585

Loan Amortisation Schedule


Year
-----1
2
3
4

Beginning
amount
------------500000
398415
282608
150588

Annual
installment
--------------171585
171585
171585
171585

Interest
----------70000
55778
39565
21082

Principal
Remaining
repaid
balance
------------------------101585
398415
115807282608
132020
150588
150503
85*

(*) rounding off error


31.

Define n as the maturity period of the loan. The value of n can be obtained from
the equation.
200,000 x PVIFA(13%, n)
PVIFA (13%, n)

=
=

1,500,000
7.500

From the tables or otherwise it can be verified that PVIFA(13,30) = 7.500


Hence the maturity period of the loan is 30 years.
32.

Expected value of iron ore mined during year 1

Rs.300 million

Expected present value of the iron ore that can be mined over the next 15 years
assuming a price escalation of 6% per annum in the price per tone of iron
= Rs.300 million x

= Rs.300 million x

33

34.

35.

1 (1 + g)n / (1 + i)n
-----------------------i-g

1 (1.06)15 / (1.16)15
0.16 0.06

= Rs.300 million x (0.74135 / 0.10)


= Rs.2224 million
(a) PV = Rs.500,000
(b) PV = 1,000,000PVIF10%,6yrs = 1,000,000 x 0.564 = Rs.564,000
(c ) PV = 60,000/r = 60,000/0.10 = Rs.600,000
(d) PV = 100,000 PVIFA10%,10yrs = 100,000 x 6.145 = Rs.614,500
(e) PV = C/(r-g) = 35,000/(0.10-0.05) = Rs.700,000
Option e has the highest present value viz. Rs.700,000
(a)

PV = c/(r g) = 12/[0.12 (-0.03)] = Rs.80 million

(b)

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

= 12 x 0.9725 / 0.15 = Rs.77.8 million

It may be noted that if g1 is the growth rate in the no. of units and g2 the growth
rate in price per unit, then the growth rate of their product, g = (1+g1)(1+g2) - 1
In this problem the growth rate in the value of oil produced, g = (1- 0.05)(1
+0.03) - 1 = - 0.0215
Present value of the wells production =
1+g n
1 - ------1+r
PV = A(1+g) -----------------

r- g
= (50,000 x 50) x ( 1-0.0215)x 1 (0.9785 / 1.10)15
0.10 + 0.0215
= $ 16,654,633
36.
The growth rate in the value of the oil production g = (1- 0.06)(1 +0.04) - 1
= - 0.0224
Present value of the wells production =
1+g n
1 - ------1+r
PV = A(1+g) ----------------r- g
= (80,000 x 60) x ( 1-0.0224)x 1 (0.9776 / 1.12)20
0.12 + 0.0224
= $ 30,781,328.93
37.

Future Value Interest Factor for Growing Annuity,


( 1+ i )n ( 1 + g)n
FVIFGA =
i-g
(1. 09)20 ( 1.08)20
So the value of the savings at the end of 20 years = 100,000 x
0.09 0.08
= Rs. 9,434,536

38
Assuming 52 weeks in an year, the effective interest rate is
0.08
1 +

52

- 1 = 1.0832 - 1 = 8.32 percent


52
MINICASE--1

Solution:
1. How much money would Ramesh need 15 years from now?
500,000 x PVIFA (10%, 15years)
+ 1,000,000 x PVIF (10%, 15years)
= 500,000 x 7.606 + 1,000,000 x 0.239
= 3,803,000 x 239,000
= Rs.4,042,000
2. How much money should Ramesh save each year for the next 15 years to be able
to meet his investment objective?
Rameshs current capital of Rs.600,000 will grow to :
600,000 (1.10)15 = 600,000 x 4.177 = Rs 2,506,200
This means that his savings in the next 15 years must grow to :
4,042,000 2,506,200 = Rs 1,535,800
So, the annual savings must be :
1,535,800

1,535,800
=

FVIFA (10%, 15 years)

= Rs.48,338
31.772

3. How much money would Ramesh need when he reaches the age of 60 to meet his
donation objective?
200,000 x PVIFA (10% , 3yrs) x PVIF (10%, 11yrs)
= 200,000 x 2.487 x 0.317 = 157,676
4. What is the present value of Rameshs life time earnings?
400,000
46
1

400,000(1.12)
2
1.12

1
1.08
= 400,000

400,000(1.12)14
15

15

0.08 0.12
= Rs.7,254,962
MINICASE--2
Solution: 1)
Re.1 deposit each at the
end of month
0 1

becomes

Rs.3.0402

12

40

Rs.3.0402 Rs.3.0402 Rs.3.0402

Rs.3.0402

44

Rs.3.0402

MBA expenses for year I at present = 20 lakhs. After 10 years it would be = 20(1+0.05) 10 = 32.58
lakhs
MBA expenses for year II at present = 25 lakhs. After 11 years it would be = 25(1+0.05) 11 =
42.76 lakhs
At the end of 3 months, each 1 Rupee deposited in the RD account becomes = FVIFA(0.08/12,3)
= [{(1+0.08/12)3 -1} / (0.08/12)] x (1+0.08/12) = {(1.00667) 3-1}/0.00667 x 1.00667 = Rs.3.0402
which when compounded quarterly becomes at the end of 10 years = 3.0402 x [(1+0.08/4) 4x10 1]/ (0.08/4)
= 3.0402 x [(1.02)40 1] / 0.02 = Rs.
183.634
For a RD maturity value of Rs.183.634 if the deposit to be made is Rs.1, for a maturity value of
Rs.32.58 lakhs, the monthly deposit to be made will be = 32,58,000/183.634 = Rs.17,742
Similarly for a maturity value of Rs.42.76 lakhs the monthly deposit needed .will be
= 42,76,000 / [3.0402 x {(1.02)44 1} / 0.02] = Rs. 20,236
2)
Amount required for Jasleens marriage at the end of 20 years = Rs.300 lakhs
Cumulative fixed deposit to be made now to get the above amount = 300,00,000 / (1+0.08/4) 4x20
= Rs.61,53,292
3)

Year end 0
19 20

What deposit?
12L

Annuity Payments

10

11

12

12L 12L 12L

Annuity Period
13
14 15

16

17

18

12L 12L 12L 12L 12L 12L

Annuity needed per annum at the beginning of each year in real terms after 10 years =
Rs.12 lakhs
With inflation at 5 percent, in nominal terms, this may be considered as a growing
annuity for
10 years at a growth rate of 5 percent and discount rate of 10 percent.
Present value of the annuity , as at the beginning of the 10th year from now
= 12,00,000 x (1+0.05)[ 1 (1+0.05)/(1+0.10)10 /(0.10-0.05)] = Rs.93,74,163
Amount to be deposited in cumulative fixed deposit now, to have a maturity value of
Rs.93,74,163 at the end of 9 years = 93,74,163/(1+0.08/4)4x9 = Rs.45,95,432

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