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THE TIME VALUE OF

MONEY

LEARNING OBJECTIVES

Understand the concept of Time value of Money.


List out the reasons for time performance of money.
Computation of compounding values.
Determine the Doubling period of an investment.
Know how to calculate the compound growth rate.
Compute present values.
Determine effective rate of interest.
Explain the applications of Time value of Money in financial
decisions.

Time value of money


A rupee that is receivable today is more valuable than a
rupee receivable in future.
Put in simple words, to days money is more valuable
was future money.

Rational of Time
Preference for Money
Uncertainty
Current consumption
Possibility of investment opportunity

Simple Interest

The interest paid on original amount or principle amount


SI = Po(I)(n).
where SI = Simple Interest
Po = Principle amount at year 0
I = Interest rate per annum
n = Number of years for which interest is calculated.
If an investor wants to know his total future value at the end of n years.
Future value is the sum of accumulated interest and the principal amount.
Symbolically
FVn = Po + Po (I) (n) or SI + Po

Compound Interest
The interest that is earned on a given deposit and has become
part of principal at the end of a specified period
CV = Po (1 + I)n
where CV = Compound value
Po = Principal amount
I= Interest per annum
n= Number of years for which compound is done.
(1 + I)n = CVIFI..n or future value inter factor for interest and
n years.

Variable Compounding Periods


CVn = Po

I
1 M

m n

where CVn = Compound value at the end of year n


Po= Principle amount at the year 0
I = Interest rate per annum
m = Number of times per year compounding is done
n = Maturity period

Compounding Growth Rate


g : Vo(1 + r)n = Vn
r

where gr = Growth rate in percentage.


V = Variable for which the growth rate is needed to
(i.e., sales, revenue, dividend at the end of year 0).
Vo = Variable value at the end of year 1.
Vn = Variable value (amount) at the end of year n.
(1 + r)n = Growth rate.

found

Compounded Value of Series of CFs


CVn = P1 (1+I)n-1 + P2 (1+I)n-2 + Pn-1(1+I)+Pn
where CVn = Compound value at the end of n year
P1 = Payment at the end of year 1
P2 = Payment at the end of year 2
Pn = Payment at the end of year n
I

= Interest rate

CVn = P1 (CVIFI.1)+ P2 (CVIFI.2) + Pn(1+II.n)

Deferred annuity- cash flow at the end


of the year. If it is even
CVn1=P (1+I)n-1
I
COMPOUND VALUE OF ANNUITY DUE
CVn=P (1+I)n-1 (1+I)
I

Doubling Period
Rule of 72 = 72/I
Rule of 69 = 0.35+(69/I)
I=Interest rate [ for example 10%, 20%, 30%, etc.]

Present Value Concept


Pv Is the future cash inflow (outflow)
is the amount of current cash that is of
n
equivalent value of the present value
Present value of single amount
PV = FVn PV = FVn (1 1+ I)
or FVn [PVIFI.n]
where PV = Present value
FVn = Future value receivable at the end of n years
I = Interest rate or discounting factor or cost of capital
n = Duration of the cash flow.
PVIFI.n = Present value interest facts at I interest and for n years

Present Value of Uneven Cash Flows


n

PV = CIFt
t = 1(1 + I)t
CIF1
+
PV =
1
(1 + I)
Where:

or

CIF2 +
(1 + I)2

CIF1
(1 + I)1

PV = Present value
CIF = Cash inflow
t = Year in which cash inflows are receivable
I = Interest rate or discounting factor or cost of capital
n = Duration of cash inflows stream

Present Value of Even Cash


Flows(deferred annuity)
PVA n =

CIF

CIF
de

(1 + I)1

(1 + I) n - 1
I (1 + I)n

CIF2 +
(1 + I)2
=

CIF (PVIFAI . n)

Where: PVA = Present value of annuity


CIF = Cash inflows
I = Discounting factor or interest rate
n = Duration of the annuity

CIFn
+ CIF n
(1 + I)
(1 + I)n-1

Annuity due
PVAn=CIF(FVIFI.n) (1+I)
OR
PVAn=CIF 1-(1+I)-n (1+I)

Sinking Fund
Sinking Fund Factor: Estimation of annual payments so as to
receive an accumulate pre-determined amount after a future
date
Ap =

FVA n
I

1 (1 I) n 1

where: A p = Annual payment


FVA n = Future value after n years
I= Interest rate
I
(1 + I)n -1

= FVIFAI . n

Loan Amortisation
Loan Amortisation: Payment of loan over a specified period
in the equal or unequal instalments
LI = PA

I (1 + I)n
(1 + I)n 1
or
LI = PA PVIFAn . I

Where: LI = Loan installment


PA = Principal amount
I = Interest rate
n = Loan repayment period
PVIFAn . I = PV interest factors at loan repayment period at specified interest rate.