Subject: Financial Management

Chapter: Two – Time Value of Money

Chapter No. 2 - Time Value of Money

Contents
♦ Introduction to the concept of “inflation” – Wholesale Price Index and Consumer Price Index
♦ Money losing value due to reduction in purchasing power
♦ Concept of interest as compensation in purchasing power of money
♦ Four tier structure for rates of interest in any economy
♦ Compounding and discounting processes
♦ Application of time value of money to business decisions
♦ Numerical exercises for practice

At the end of the chapter the student will be able to

♦ Determine - Future value of a present sum by compounding
♦ Determine - Present value of a future sum by discounting
♦ Determine - Present value of a bond investment
♦ Explain - the different tiers of interest structure in an economy
♦ Choose – the best project based on its “Net Present Value”

Concept of “Inflation” – Wholesale Price Index and Consumer Price Index

Inflation means to increase. In this context, it means increase in prices of commodities. The price increase is due to the
difference between “supply” and “demand” for a given commodity. If the supply is more than demand, prices
decline and if the demand is more, prices increase. In a developing country like India, the demand for most of the
commodities will always be more than the supply. Hence “inflation” will always be experienced in developing
markets.
The increase is constantly measured in all the countries. The items included for determining the prices would be
different from country to country. For example, in India, essential commodities like sugar, kerosene, a loaf of bread
etc. are included in the basket of commodities considered for calculation of “inflation”. Different from this, in a
developed country, items that are luxury items in a developing country would also be included. For example,
automobile could be included. The increase is expressed in % terms. For example if the rate of inflation is 5%, this
means that over a period of one year, the prices have increased by 5%. The details of inflation are published regularly
in all leading dailies in the country.

Wholesale price and not the retail price

The prices of the selected commodities for determining the rate of inflation over a period of one year could be on the
wholesale or retail. The latter one is mostly referred to as “consumer price”. Thus we have a “wholesale price index”
and “consumer price index” for expressing rates of inflation. Conventionally in India the rate of inflation has always
been expressed in “wholesale price index” basis rather than “consumer price index” basis although the consumer

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price index increase is also published regularly. At present the wholesale price index inflation is around 3%. We will
explain this concept through an example.
Example no. 1
I had spent Rs. 100/- in getting a basket of commodities one year ago. If the rate of inflation is say 3%, now I will be
required to spend Rs. 103/- to get the same basket of commodities. How do we get Rs.103/-? Rs. 100/- x 1.03 = Rs.
103/-. This means that due to “inflation”, the purchasing power of the local currency decreases with the passage of
time. This is exactly the concept of “time value of money”. In simple words, “time value of money” means that with
the passage of time, money loses its value.

Is there a situation in which the prices decrease over a period of time and opposite of “inflation” takes
place?
Usually in a developing country, such a situation does not arise, as the demand is always greater than supply.
However currently Japan is experiencing “deflation” in which current prices would be less than the past prices. This
is harmful to a developing economy, as units that save money would get very low interest or no interest. Hence there
will be no incentive for the units to invest money in bonds, fixed deposits etc.

Concept of Interest as compensation for loss of purchasing power due to “inflation”:

You keep money in a deposit with a bank. It could be a Savings Bank or a Fixed Deposit. What does the bank pay to
you? “Interest”. This is the “return” on your investment. Why should the bank pay interest to you? Let us enumerate
the possible reasons for the bank’s action.
♦ The bank does the business of lending. For this, it requires funds through deposits. It earns interest on loans
and pays interest on deposits;
♦ With the passage of time, the purchasing power of money reduces. The same thing will happen to your
deposit with the bank. The bank gives compensation to you for this loss in value of money;
♦ In case the bank does not pay interest, it will not get funds for lending. You will not keep deposits with it.
You will choose other willing banks or avenues of investment.
While all of them are correct, we are more interested in the second reason. Value of money erodes due to “inflation”
as we have seen in the earlier paragraph. The rates of inflation would be different for different countries. Further, it
could be different for the same country at different times. Sometimes it could be high while at some other times, it
could be low.
Note:1
Would interest be less in case the rate of inflation comes down?
Absolutely. As an example, we have already seen what is happening in Japan. The Japanese banks are practically not
paying interest on deposits right now. The rate of inflation in the US is around 2% p.a. and accordingly the rate of
interest on investment would be around 3% to 3.5% p.a. Thus the rate of inflation in a country and the rate of interest
on investment are closely linked to each other. For further details, please look at the “Tier structure” of rates of
interest given below.
Consider Indian market conditions. Hypothetically if the inflation comes down to say 1%, the rat e of interest on bank
deposits and bank loans in turn would also come down. The banks would not pay the current rate of interest. If the
students may recall in India, the rates of interest on savings are constantly coming down. This is the result of the rate
of inflation coming down constantly at least till the last year.

Four tier structure for rates of interest in any economy

1
“Rate of inflation coming down” - What does it mean? Does it mean that the prices of commodities are coming down or the increase in prices of
commodities is coming down? – Answer is: The increase in prices of commodities is coming down; in actual terms, the prices of commodities are
not reducing.

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The starting point for any interest is the rate of inflation in the economy. Like for example, in India at present, it is
around 3% now. We have seen earlier that interest is the compensation for loss of purchasing power of Indian Rupee.
This loss is due to the phenomenon of “inflation”. We have also learnt that the banks would normally offer a rate of
interest higher than the rate of inflation. Based on this, let us construct a 4-tier system of interest rates. This would
build up stage-wise rates of interest till investment in a project.
Tier 1 – Rate of inflation, say 3%
Tier 2 – Rate of interest on investment say in bank deposit
Rate of inflation + some compensation from the acceptor of deposits, say banks. = 3% + 4% = 7%, that is the lowest
interest offered by a public sector bank now on fixed deposits. The exact premium paid to the depositor depends on
the following:
♦ The duration of the deposit – the longer the duration, the higher the premium and vice-versa. That is why
the longer duration deposits would attract higher rates of interest and shorter duration deposits would have
a lower rate of interest.
♦ The need for deposits by the banking company for a specific period. The bank would offer a higher rate for
that period. Suppose a bank wants more deposits for six months rather than one year. It will attract deposits
for six months by offering higher rate of interest than the market.
Tier 3 – What does the bank do with the deposits that it accepts? It gives loans. The rate of interest on loans becomes
the next tier, Tier 3.

What are the factors that a bank would consider to determine its lending rate?
Average interest paid out on deposits and expenses
Minimum expected profit from lending operations
Degree of risk in lending – specific to a borrower, depending upon his business
Continuing discussion on Tier 3, we see that the minimum rate of interest on loans would be 7% + 3% + 1% = 11%.
This is the lowest interest that any bank offers now in India on loans. There is a specific name for this rate. It is
referred to as “Prime Lending Rate” or PLR. The bank would add further to this rate depending upon risk etc., which
is called “risk premium”2. This would again be different from borrower to borrower.

Why discuss about a loan here?

Who takes loans in a big way from the banks? This does not refer to the housing or consumer loans taken by salaried
persons. Obviously, business enterprises. It is for investment in their business/projects. Hence the rate of return on a
project would be the last Tier, called “Tier 4”.
Can you determine this rate? Yes and no. Yes, as you will be able to determine a formula for this. No, because, it is
not always possible to evaluate risk associated with a project correctly.
The formula is:
Rate of interest on loans, say 11% + compensation for the additional risk taken by the project owner. For an outsider,
it will not be possible to put a figure on this. This will depend upon the risk associated with the specific project.
From whose point of view? - Both from the points of view of the owner and the lender/investor. This compensation
is referred to as “risk premium” of the project.
The question that could come to one’s mind while reading these lines is:

2
This is the reason that for different activities, the same bank charges different rates of interest at the same time. Similarly for
different borrowers pursuing the same activity, the rates of interest would be different as per perception of risk associated with
them.

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Why should a project owner expect a higher rate of return than the rate of interest on loans?
Consider the following and learn the risk associated with a project.
♦ The project owner’s investment does not have the backing of assets. A lender, on the contrary, has backing
of assets for his loan.
♦ The enterprise pays the lender interest periodically. The owners on the contrary, get return in the form of
dividend. This is not certain.
♦ Besides interest, the enterprise should also have sufficient surplus after paying interest to repay the loan
amount
♦ Risk of project failure affects the owners more than the lenders for the same reason as mentioned in the first
bullet point

Example No. 2
Let us summarise the above as under:
Rate of inflation = Tier no. 1 = 3% p.a.
Rate of interest on investment = Tier no. 2 = 7% p.a.
Rate of interest on loans = Tier no. 3 = 11% p.a.
Rate of return from investment in projects = Tier no. 4 = 15% p.a. (This is just an example. The rate of return expected
from a project would actually depend upon the degree of risk associated with the project in the perception of the
project owners primarily and project lenders secondarily)

Future value of Re.1 - Process of compounding

Refer to Example no. 1. We found out that we would require Rs.103/- to purchase a basket of commodities that we
could purchase at Rs.100/- a year ago and the rate of inflation works out to 3% p.a. Can we give another name for the
value after one year? Yes. It is called the “future value”, while Rs.100/- is called the present value. The other name for
the future value is “compounded value” as this is obtained by a process called “compounding”.

Can we have a formula for this process of compounding?

n
Future value (F.V.) at T1 = PV at T0 x (1+r/100) , wherein T1 is the end of year 1 and T0 is the beginning of year 1.

n
(1 + r/100) is known as compounding factor.

Let us apply this formula to another investment example and determine the future value.

Example no. 3
You have a fixed deposit for Rs.10,000/- in a bank. Terms of deposit are:
Period – Two years
Rate of interest = 10% p.a.
The bank does not pay interest periodically. Interest gets accumulated to the principal amount; it gets paid at the end
of the period along with principal amount.
What is the future value of this investment?
The future value is Rs.12,100/-. In the compounding formula, by substituting 10% for “r” and 2 for “n”, we get this
value. The break-up of principal and interest amount for the period of investment, i.e., two years is as under:

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Principal – Rs.10,000/-
Interest – Rs.2,100/-

Does the future value alter with the change in the frequency of compounding?
In the above example, we have assumed that the bank pays interest at the frequency of one year. Suppose the bank
pays interest at a higher frequency, would the future value turn out to be different? Let us see the following example.

Example no. 4
Suppose the bank increases the frequency of compounding from yearly to half-yearly. What will be the future value?
We can use the same formula with an amendment. The amended formula would be:

Future value = Present investment x (1 + r/200) n x 2

As interest gets compounded twice as frequently, r is divided by 200. Similarly the number of periods for
compounding also gets doubled and hence it is 2 x n instead of “n”. Accordingly, in our formula, what would be the
values of “r” and “n”?
r = 5% and n = 4

With these values, the future value FV at T2 works out to 10,000 x (1.05) 4 = Rs.12,155/-.
Similarly we can see that in case the frequency of compounding increases to quarterly from half-yearly, the future
value works out to Rs. 12,184/-.

Let us summarise what we have learnt so far on “compounding and future value”:
♦ The amount that you get back at the end is called “future value”
♦ Future value is determined by “compounding”
♦ Future value depends upon:
♦ Rate of interest and
♦ Frequency of compounding
♦ The multiplying factor is known as “compounding factor”
♦ The more the frequency, the higher the amount of interest

Doubling period
A frequent question posed by an investor is: “How much time it will take for my investment to double in value”?
This question can be answered by a rule known as “Rule of 72”. It is an approximate way of finding out the doubling
period. Suppose the rate of interest is 12%. The doubling period is 6 years.
A more accurate answer can be had by a better formula like:
0.35 + 69/interest rate in % terms. Employing the same rate of 12%, we find that the doubling period is 6.10 years
instead of 6 years. This is more accurate than the Rule of 72 formula.

Present value of a future rupee – Process of discounting

So far we have seen “future value”. We are now going to see “present value” of a future sum. Suppose we want to
have Rs.10,000/- after say two years (T 2). We want to know how much we should save now (T 0). This situation is

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exactly the opposite of the earlier future value situation. The investment at T 0 should increase to the desired future
value at a desired rate of interest. The process of determining the present value from future value is known as
“discounting”. “Discounting” is converse of “compounding”.

Example no. 5

We want to get Rs.108/- at the end of T1. The desired rate of interest is 8% per annum. What is the amount that we
should invest at T0?
Can we use the “future value” formula here?
Yes – with necessary modification as under:
n
Future value = Present investment x (1 + r/100)

Future value at T1, Rs.108/- = PV at T0 (to be determined) x (1.08)

PV at T0 = Rs. 108/1.08 = Rs.100/-.

Thus the formula for present value is as under:

n
Present value = Future value = Future value x [1/(1 + r/100) ]

--------------------
n
(1 + r/100)

The reciprocal of compounding factor is referred to as “discounting factor. We need to multiply the future value by
n
this discounting factor and not divide. In the above formula, 1/(1+r/100) is referred to as “discounting factor”.

Discounting factor = 1/compounding factor; discounting factor x compounding factor = 1. Discounting factor
would always be less than 1.

Example no. 6
We want to get Rs.10,000/- after two years. The desired rate of interest is 12% p.a. The frequency of is yearly.
What is the present value of this future sum of Rs.10,000/-?
Present value = Rs. 7,971/-
The two-step process in determining present value is:

Step 1 = determine the discounting factor = 1/[1 + 12/200]4 = 0.7924

Step 2 = multiply the future value by this factor to get the present value
Present value of Rs.10,000/- = Rs.7,924/-

We have already seen under “future value” that higher frequency of compounding increases the future value.
Conversely, higher frequency of discounting decreases the present value. The students are advised to take the
following exercise and verify for themselves.

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Exercise No. 1
After three years we are likely to get a windfall of Rs.1,00,000/-. What will be the present value of this windfall, in
case the expected rate of return is 15% p.a.?
Answer – Rs.65,751/-
Let us summarise what you have learnt so far on “discounting and present value”:
♦ Discounting is the converse of compounding
♦ It is used when you want to determine the present value of a future sum
♦ Just as there is a compounding factor, there is a discounting factor
♦ In case you determine the discounting factor, you should multiply the future value by this factor to get the
present value
♦ The more the frequency the of discounting, the less will be the value of present value
♦ Present value will always be less than future value by the same token of inflation.

Application of concepts of future value and present value in business

Where does one apply the future value and present value in business?
As discussed earlier, future value is helpful in determining the compounded return of an investment and hence is
more useful in the case of personal investment.
However, in the case of discounted value, the relevance is more to business. The following example illustrates this.

Example no. 6 - Application 1

We want to start an Industrial project at T0 with an investment of Rs.100 lacs.

We expect to get a return of 20% from the project.
The estimated future earnings are:

T1 – Rs.30 lacs

T2 – Rs.35 lacs

T3 – Rs.40 lacs

T4 – Rs.45 lacs

We want to evaluate our investment decision in the project. How do we do this? By applying discounting factor for
20% to the future earnings.

Present value of T1 = Value at T0 = Rs. 30lacs/1.20 = Rs.25 lacs

Present value of T2 = Value at T0 = Rs.35 lacs/(1.20)2 = Rs.24.30 lacs

Present value of T3 = Value at T0 = Rs.40 lacs/(1.20)3 = Rs.23.14 lacs

And Present value of T4 = Value atT0 = Rs.45 lacs/(1.20)4 = Rs.21.69 lacs

The “sum total” of all the T0 values = Rs.94.13 lacs = Present value of future earnings for a period of four years.

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What does this mean? It means that at 20% expected return the project has given back only Rs.94.13 lacs. This is
against Rs.100 lacs that have been invested in it. That is, the present value of future earnings is less than original
investment. Hence we will not invest in the project. The difference between the present value of future earnings and the
investment at T0 is called the “Net present value” or NPV. This is one of the fundamental methods of selecting a
project.

Here is how we can use it for selecting a project:

♦ Determine the amount we need to invest in a project.
♦ Estimate future earnings from the project on certain working assumptions.
♦ Discount the future earnings by a suitable rate of discount. This depends upon the market rate for
borrowing and our perception of risk in the project. This gives the present value of all future earnings.
♦ Compare this with the present value of investment. We invest in the project if the present value of the future
earnings is more than present value of investment.
♦ In the above example, suppose the present value is greater than Rs.100 lacs. Then we would select the
project for investment.

Exercise No. 2
We are investing in a project Rs. 1000 lacs. The rate of return that we expect from the project is 18% p.a. The estimated
future earnings for three years are:

T1 = Rs.450 lacs

T2 = Rs.500 lacs

T3 = Rs.550 lacs
The above are also referred to as cash flows 3(in this case cash inflows)
Examine as to whether it is worthwhile investing in the project. Find out the Net Present Value of the project.

Answer:
Present value of future earnings = Rs.1071 lacs
Net Present Value = Rs.71 lacs
We can invest in the project

Example No. 7 - Application 2

Suppose there is a bond that has been floated in the market with face value of Rs.1000/-. The interest per year is
Rs.100/-. The period is 5 years. The expected rate of return is 8% p.a. What is the price at which an investor will be
willing to purchase the bond from the market now?

Step 1 = to construct the future returns including the principal amount

Year from now Payment expected (cash inflow)
1 Rs.100/-

3
Cash flow could either be cash inflow or cash outflow. When an investment is made at T 0 it is called “cash out flow”. Similarly when returns are
received they are called “cash in flows. Cash out flow is denoted by mentioning the figure within bracket like (50 lacs)

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2 Rs.100/-
3 Rs.100/-
4 Rs.100/-
5 Rs.1100/-

Step 2 = discounting the payment expected by the rate of return, i.e., 8% p.a., we can determine the present value of
the future cash flows. It is Rs.1080.30. This means that an investor will be willing to purchase this bond now from the
market provided the market price of this bond is less than Rs.1080.30.

Exercise No. 3
We have a bond with the face value of Rs.5,000/-. The interest on the bond is Rs.600/- per year. We are supposed to
get a premium on the bond of Rs.250/- at the end of the maturity period. Expected rate of return by us = 10% p.a.
Suppose the maturity is after 5 years, what is the price at which an investor would be willing to purchase it from us?
(Note – please add the premium amount to the face value. You will get Rs.5,250/- on maturity)
Answer: Present value of future returns = Rs.5534/-. An investor will be willing to pay anything less than this
value for purchasing the bond from you.

Example no. 8 - Application 3

Evaluation of opening of a branch office by discounting the expected future returns at a suitable rate of discount and
comparing the present value with the investment required in capital assets to open a branch office.
As you will have realised by now, the investment in a branch office is very similar to investment in a project. You are
investing in a project to get returns from it. Similarly, you invest in a branch office based on expectation of additional
returns.
As it is very similar to a project, separate example or exercise is not given here.

Example No. 9 - Application 4

Suppose we develop a product by spending say Rs.10 lacs. This amount will be recovered along with profit through
sales of a number of units over a period of time. Suppose we project sales in unit terms as well as value terms over a
period of time. Let us assume this period to be three years. Suppose the expected rate of return is 15% p.a. Further,
assume projected sales for the next three years to be as under:
No. of units expected to be sold Unit Rate Expected sales in lacs of Rupees
2000 Rs.250/- Rs.5 lacs
2200 Rs.250/- Rs.5.5 lacs
2500 Rs.250/- Rs.6.25 lacs

This is similar to finding out the net present value in the case of projects. We discount the expected sales by the
expected rate of return of 15% p.a. This determines the present value of the expected sales. Let us compare this with
the total product development expenses.

Exercise No. 4
Find out the net present value in the above example. Also confirm that the total product development costs stand
fully recovered at T3.

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Answer – The product development costs stand fully recovered at T3.

Let us summarise what we have learnt on application of “Time value of money” to business
♦ Compounding and discounting have a number of applications to Finance decisions.
♦ Compounding has greater application to personal investment while discounting has greater application to
business.
♦ Discounting is useful in a number of decisions like project, product development, opening a branch office
etc.
♦ Bond valuation is also done through discounting.

Let us look at one more example for reinforcing our learning. Let us select the best project out of the
three projects proposed.
Consider the following 3 alternative projects. Assumptions are also given below:

Investment at T0 for all the projects is Rs.500 lacs.

Future cash flows are considered for T1 to T5.

Although the scale of operations for all the projects is the same, the projects have different future earnings or returns.
The promoters expect a rate of return of 15% p.a. hence; this is the rate by which the future returns are discounted.

(Rupees in Lacs)
Project 1 Project 2 Project 3

Year Future Future Future

Disc. Value Disc. Value Disc. Value
No. Earnings Earnings Earnings

1 100 86.96 150 130.44 175 152.18

2 120 90.73 150 113.42 150 113.42

3 200 131.5 150 98.63 180 118.35

4 250 142.95 200 114.36 225 128.66

5 250 124.3 200 99.44 250 124.3

Total 576.4 556.29 636.91

As Project 3 has the highest NPV it would be selected. NPV = PV of future earnings (-) original investment.
Accordingly, the net present values for the three projects would be:
Project 1 76.44 lacs

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Project 2 56.29 lacs

Project 3 136.91 lacs
On the basis of net present value, project 3 would get selected.

Concept of annuity
So far we have seen the following in respect of application of time value of money:

Investment lump sum at T0 and get lump sum at Tn = Future value; process is “compounding”. This is called future
value of a single stream.
Suppose we are given a future value and want to know how much should be invested at present. We use the process
that is converse of compounding and this is called “discounting”. In order to get lump sum after a given period, we
should invest the present value at the beginning, again a lump sum. This is called the present value of a single
stream.

Invest lump sum at T0 in a project and get annual returns. The returns will not be equal to each other. To determine
the present value of the future returns to determine Net Present Value = Present value; process is “discounting”. This
is the example of present value of multiple streams.
Annuity refers to “multiple stream” of cash flows but which are equal to each other and occurring annually. The
cash flows could either be in flows or out flows. This means that the following alternatives are available to us when
we are talking of “annuity”.
♦ We invest at the beginning one lump sum amount and get returns over a period of time that are equal
to each other. The cash in flows that are equal to each other are called “annuity”. Herein we use what
is known as Present Value Interest Factor Annuity (PVIFA). We multiply the Annuity by this factor
and get the present value of the future cash flows in one shot. Then we compare this present value with
our proposed investment at T0 taking decision on investment. We invest provided the Present value of
future annuities is at least equal to our investment at T0.

♦ We invest in equal instalments over a period of time and get one lump sum at the end of the period.
The cash outflows that are equal to each other are called “annuity”. Herein we use what is known as
Future Value Interest Factor Annuity (FVIFA) .We multiply the Annuity by this factor and get the
future value of the cash out flows in one shot.
Let us study the following examples to understand the concept of “annuity”.
Example no. 10
We are able to invest every year Rs.1000/- for a period of 5 years. We expect a return of 10% p.a. What will be the
value of this investment at the end of 5 years?
Let us represent this by way of a timeline

At T0 T1 T2 T3 T4 T5
Investment = zero 1,000/- 1,000/- 1,000/- 1,000/- 1,000/-

Can we use the future value formula, find out the future value of each stream of Rs.1000/- and add them up? Thus T 1
investment would earn interest for 4 years, the 2nd year investment would earn interest for 3 years, the 3rd year
investment would earn interest for 2 years, the 4 th year investment would earn interest for 1 year and the last year
investment would not earn any interest. Instead of doing such an elaborate exercise, we use the alternative “FVIFA”.
Practical applications of “Annuity”4 for future value

4
Annuity could be at a frequency more than one year. In fact in the case of recurring deposit, the annuity is monthly.

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♦ Life Insurance policy premium

♦ Recurring deposit account with a bank

Example no. 11

Similar in concept to Example no. 10, we can think of investment lump sum at T0 and getting returns over a period of
time, the returns being equal in value. Example is investment in bank deposit floated by competitive banking
industry at present. Each return will be partly principal amount and partly interest amount. Our aim is to determine
the present value of the future returns by discounting them and comparing the present value with our investment
value.

Can we use PVIF and find out the present value of future cash flows? Yes. The cash flow at T 1 is discounted for one
year, the cash flow at the end of the second year is discounted for two years, the cash flow at the end of the third year
is discounted for three years and so on and so forth. Instead of repeating the discounting process so many times, we
have the easy alternative of Present Value Interest Factor Annuity.
It is okay for discussion. However the students will be interested in knowing as to where he will get the PVIFA and
FVIFA values. These will be available as annexure with any standard textbook on “Financial Management” and
multiply with the annuity to arrive at the Present Value or Future value as the case may be.

Concept of perpetuity
This is the concept applicable in the case of pension. Pension is taken to be perpetual. Can we find out the lump sum
amount in case the pension amount is given?
Example no. 12
Suppose the pension amount is Rs. 1000/-. The expected rate of return is 10% p.a. What is the core amount out of
which interest is paid? The annual payment is Rs.12,000/-. Hence the lump sum amount is Annual payment/rate of
interest expressed in decimals.
Accordingly the lump sum amount is Rs. 12,000/0.1 = Rs. 1,20,000/-.

Questions for reinforcement of learning and numerical exercises for practice

1. Why should return from a project be the highest in the 4-tier interest rate structure?
2. Future value interest factor x Present value interest factor = -----------------------
3. Can you find out the present value of a stream of annuity without using PVIFA? Explain the process.
4. Find out the present value of a sum of Rs. 10 lacs at the end of five years in case the expected rate of return is
12% and the compounding is done on half-yearly basis.
5. Suppose you open a recurring deposit account with annual interest of 6%. You open it for a period of 12 months.
The annuity is Rs.500/-. What will be the value at the end of one year?
6. Mr. George is about to retire. The employer places before him two alternatives. Mr. George has to choose
between them. Lump sum Rs. 12 lacs or half-yearly pension of Rs. 79,000/-. Which one should he choose in case
the annual expected return is 10%?
7. What is the present value of an income stream that provides Rs. 2,000/- at the end of year one, Rs. 5000/- at the
end of year two and Rs.10,000/- for the next 5 years? Assume the rate of interest to be 8% p.a.

8. What is the present value of Rs. 5,000/- receivable annually for 30 years if the first receipt occurs after 5 years
and the rate of interest is 10% p.a?

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Subject: Financial Management
Chapter: Two – Time Value of Money

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