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2 - Time Value of Money
2 - Time Value of Money
Time Line
Cash Flows at-the-end of period
Cash Flows of Rs 1000/- each at Year-end for 4 years
1000
0
Period 1
1000
Period 2
1000
Period 3
1000
Period 4
Period 1
1000
1000
1000
Period 2
Period 3
Period 4
04-Oct-2013
5
FV
@ r%
0
P
3
@ r%
5
FV
04-Oct-2013
Future Value
0
5
FV
@ r%
0
P = 1,000
3
@ 5%
5
FV = 1,276.28
1000*(1.05)5
Future Value
Values of FVIF for various combinations of r and n are
given in Future Value Interest Factor tables.
FVIF (6 yrs,5%)
04-Oct-2013
1,54,033
80,000
0
04-Oct-2013
Future Value
=FV(Interest Rate, Time,, Present
Value,0(or1))
Compounding Rate (r)
Time Period (N)
Present Value (PVN)
Future value
5900
5400
18%
Future Value
4900
4400
15%
3900
3400
12%
2900
10%
2400
8%
1900
5%
1400
900
1
10
Years
10
04-Oct-2013
)n*m
m
where m is no. of times interest is paid.
Future Value
04-Oct-2013
Frequency (m)
Annual
1
Semi-annual 2
Quarterly
4
Monthly
12
Daily
365
Continuous
Nominal
Rate
10%
10%
10%
10%
10%
10%
Future
Value
1100.00
(1.10)-1
1102.50 (1+ 0.10/2)2 - 1
1103.81 (1+ 0.10/4)4 - 1
1104.71 (1+ 0.10/12)12 - 1
1105.15 (1+ 0.10/365)365 - 1
1105.17
exp (0.10) - 1
Effective
Annual Rate
10.0000%
10.2500%
10.3813%
10.4713%
10.5156%
10.5171%
13
Present Value
The process of calculating the present value of the future Cash
Flows is called discounting and the interest rate used for
discounting is called the discount rate.
14
04-Oct-2013
PVIF
(6 yrs,5%)
15
??
10,000=P*(1.06)3
PV=
10,000
=10,000*0.8396=Rs.8,396/(1.06)3
16
04-Oct-2013
17
Present Value
=PV(Interest Rate, Time,,
-Future Value, 0(or1))
04-Oct-2013
Present Value
800
700
5%
600
500
400
300
18%
200
100
1
10
Years
19
Annuity
Annuity is a stream of n equal cash flows (inflows or
outflows) at regular intervals.
If each investment is made at the END of each period, the
annuity is called Regular Annuity or Annuity in arrears
0
3
A
n-1
A
20
10
04-Oct-2013
n-2
n-1
A
n
A
A(1+r)n-1
A(1+r)n-2
A(1+r)n-3
A(1+r)2
A(1+r)1
(1+r)n -1
FVARA = A
21
n-2
n-1
A(1+r)n
A(1+r)n-1
A(1+r)n-2
A(1+r)2
A(1+r)1
(1+r)n -1
FVA AD = A
(1+r)
r
22
11
04-Oct-2013
23
24
12
04-Oct-2013
50,000
??
(1.08)5 -1
FVARA = 50,000
= 50,000*5.8666= Rs.2,93,330/ 0.08
Case-2 Annuity Due:
??
(1.08) -1
FVA AD = 50,000
(1.08) = 50,000*6.3359= Rs.3,16,796/0.08
25
1
1
2
2
3
3
n-2
n-2
A
n-1
n-1
n
n
A/(1+r)1
A/(1+r)2
A/(1+r)3
A/(1+r)n-2
A/(1+r)n-1
A/(1+r)n
PVARA =
A
A
A
A
A
A
+
+
+.........+
+
+
1
2
3
n-2
n-1
(1+r) (1+r) (1+r)
(1+r)
(1+r)
(1+r)n
1
1
PVARA =A n
r r(1+r)
26
13
04-Oct-2013
2
1
3
2
4
3
n-1
n-2
n
n-1
A/(1+r)1
A/(1+r)2
A/(1+r)3
A/(1+r)n-2
A/(1+r)n-1
PVA AD = A+
A
A
A
A
A
+
+
+.........+
+
1
2
3
n-2
(1+r) (1+r) (1+r)
(1+r)
(1+r)n-1
1
1
PVA AD =A (1+r)
n
r r(1+r)
27
28
14
04-Oct-2013
29
30
15
04-Oct-2013
1
1
=50000
30 =50000*10.2737=Rs.5,13,683/ 0.09 0.09(1.09)
31
PVARA =A 2,50,000 = A
n
5
r r(1+r)
0.08 0.08(1.08)
2,50,000
A=
= 62,614/3.9927
Opening
Balance
(1)
Annual
Instalment
(2)
250,000
2
3
4
5
207,386
161,363
111,658
57,976
Year
Interest
(3) = (1)*8%
Principal
Repayment
(4) = (2)-(3)
Closing
Balance
(5) = (1)-(4)
62,614
20,000
42,614
207,386
62,614
62,614
62,614
62,614
16,591
12,909
8,933
4,637
46,023
49,705
53,682
57,977
161,363
111,658
57,976
0
3,13,070
63,070
2,50,000
32
16
04-Oct-2013
Installments
=PMT(Interest Rate, Time,
-Loan Amount,,Type)
Discounting Rate
Time Period
Loan Amount
= 0 End of period
= 1 Start of period
17
04-Oct-2013
18
04-Oct-2013
19
04-Oct-2013
Growing Annuity
Growing Annuity is a stream of n cash flows growing @ g, paid
at regular intervals.
Growing Regular Annuity:
0
A(1+g)
A(1+g)2
A(1+g)n-1
n-1
A(1+g)n-1
39
A(1+g)
A(1+g)2
n-1
A(1+g)n-2
n
A(1+g)n-1
A
(1 + r) 1
A (1 + g )1
(1 + r) 2
A (1 + g ) 2
(1 + r ) 3
A (1 + g ) n -2
(1 + r )n -1
A (1 + g )n -1
(1 + r )n
A
A(1+g) A(1+g)2
A(1+g)n-1
PVGARA =
+
+
+......+
(1+r)1 (1+r)2
(1+r)3
(1+r)n
A 1+g
PVGA RA =
1r-g 1+r
For g r
40
20
04-Oct-2013
1
2
3
A(1+g) A(1+g)2 A(1+g)3
n-1
A(1+g)n-1
A(1+g)
(1+r)1
A(1+g)2
(1+r)2
A(1+g)3
(1+r)3
A(1+g)n-1
(1+r)n-1
A
A(1+g)1 A(1+g)2
A(1+g)n-1
PVGA AD =
+
+
+......+
(1+r)0 (1+r)1
(1+r)2
(1+r)n-1
A 1+g
PVGA AD =
1-
r-g 1+r
(1+r) For g r
41
10,000 1.10
PVGA RA =
10.08 - 0.10 1..08
= Rs.48,042/
10,000 1.10
PVGA AD =
10.08 - 0.10 1..08
(1.08) = Rs.51,886/
42
21
04-Oct-2013
1
A
n-1
A(1+g)n-2 A(1+g)n-1
A(1+g) A(1+g)2
A
(1+r)1
A(1+g)1
(1+r)2
A(1+g)2
(1+r)3
A(1+g)n-2
(1+r)n-1
A(1+g)n-1
(1+r)n
A 1+g
=
FVGA RA = PVGA RA *(1+r)
1r-g 1+r
n
n
*(1+r)
43
n-1
A(1+g)
A(1+g)2
A(1+g)3
A(1+g)n-1
A(1+g)
(1+r)1
A(1+g)2
(1+r)2
A(1+g)3
(1+r)3
A(1+g)n-1
(1+r)n-1
FVGA AD = PVGA
AD
*(1+r)n
n
A (1+ r) 1+g
n
FV G A A D =
1-
*(1+r)
r-g 1+r
44
22
04-Oct-2013
Mr. Sairam is 35 years old now and wants to save each year until he
is 65. If he saves Rs 10,000/- every year and the savings grow@ 5%
pa (after the first year),how much will he have saved by age 65 if
the interest rate is 10% pa?
35
0
36
1
10,000
37
2
10,000(1.05)
38
3
10,000(1.05)2
10,000 1.05
PVGA =
10.10 - 0.05 1.10
30
65
30
10,000(1.05)29
= Rs. 1,50,464/
Perpetuity
Perpetuity is a stream of equal cash flows at regular
intervals which lasts forever.
0
PVP=
A
A
A
+
+
+......
1
2
(1+r) (1+r) (1+r)3
PVP=
A
r
46
23
04-Oct-2013
Perpetuity
You want to endow an annual MBA graduation party at your alma
amter. The event would cost Rs.50,000/- each year forever. If the
business school earns @ 8%p.a. on its investments and the first
party is in one years time, how much will you need to donate to
endow the party?
PVGP=
PVGP=
50,000
=Rs.6,25,000/0.08
47
Growing Perpetuity
1
A
2
A(1+g)
A(1+g)2
A(1+g)3
A
A(1+g) A(1+g)2 A(1+g)3
PVGP=
+
+
+
......
(1+r)1 (1+r)2
(1+r)3
(1+r)4
PVGP=
A
r-g
48
24
04-Oct-2013
Growing Perpetuity
But then you are informed that the cost of the party would increase
by 4% per year, (after the first year).How much will you now need
to donate to endow the party?
PV=
50,000
=Rs.12,50,000/0.08 - 0.04
49
Summary
Annuity
(Regular Annuity)
Present Value
1
C
(1+r)n
1 1
A n
r r(1+r)
Annuity
(Annuity Due)
1 1
A (1+r)
n
r r(1+r)
Growing Annuity
(Regular Annuity)
Growing Annuity
(Annuity Due)
Perpetuity
Growing Perpetuity
n
A 1+g
1
r-g 1+r
n
A 1+g
1-
(1+r)
r-g 1+r
Future Value
C(1+r)n
(1+r)n -1
A
(1+r)n -1
A
(1+r)
r
A 1+g
1r-g 1+r
(1+r)n
n
A(1+r) 1+g
1 (1+r)n
r-g 1+r
n
A
r
A
r-g
50
25
04-Oct-2013
Where to Invest ?
Atul want to invest Rs. 10 Lac for a period of 10 years. He can invest in
Government bonds which mature in 6 years and earn interest @ 8%
pa. The expected fixed deposit rate for 6 years hence, given by a local
bank is 3.5% pa, with half yearly compounding. Meanwhile, Yep Bank
has offered an investment proposal offering 6.5% pa with quarterly
compounding for 10 years. Which proposal is better for Atul?
Option 1: Invest in Government Bonds @ 8% pa for 6 years & @ 3.5%
pa (half yearly compounding) in bank fixed deposit for next 4 years
thereafter.
10,00,000 * (1.01625)40 = 10,00,000* 1.90556 = Rs. 19,05,560/Better to deposit with Yep Bank.
51
52
26
04-Oct-2013
Valuation of Securities
??
Value of ZCB =
V0 =
Fn
(1+r)n
5,000
= Rs.4,319.19
(1.05)3
54
27
04-Oct-2013
A+F
A/(1+r)1
A/(1+r)2
A/(1+r)3
A/(1+r)4
A+F/(1+r)5
n
A
A
A
A
F
V0 =
+
+
+.....+
+ n n
1
2
3
n
(1+r) (1+r) (1+r)
(1+r) (1+r)
55
At
F
+
t
(1+r)5
t=1 (1+r)
V0 =
5
=
t=1
1,400 10,000
+
(1.10)t (1.10)5
28
04-Oct-2013
Value =
D1
D
D
D
+ 2 + 3 +..........+
(1+r)1 (1+r)2 (1+r)3
(1+r)
Dt
t
t=1 (1+r)
Value =
57
D1
D1 (1+g)1 D1 (1+g)2 D1 (1+g)3
V0 =
+
+
+
+..........+
(1+r)1
(1+r)2
(1+r)3
(1+r)4
V0 =
D1
(r - g)
Assumptions:
D1 > 0
Dividends grow at a constant growth rate g =ROE*b
Dividend Payout ratio (1-b) is constant
58
29
04-Oct-2013
Value =
D1
3.00
=
= Rs.50/(r - g) (0.13 - 0.07)
59
D1
D1 (1+g 1 )1 D 2 (1+g 2 ) D 2 (1+g 2 )2
V0 =
+
+
+
+..........+
(1+r)1
(1+r)2
(1+r)3
(1+r)4
n
Dt-1 (1+g t ) Vn
Dn+1
+
where
V
=
n
(1+r)t
(1+r)n
r - gn
t=1
V0 =
D (1+g ) 1 Dn+1
V0= t-1 t t +
n
(1+r)
(1+r)
r
g
t=1
n
n
60
30
04-Oct-2013
1
2
3
4
5
6
6
(1.12) (1.12) (1.12) (1.12) (1.12) (1.12) (0.12 - 0.08) (1.12)
P0 = 124.78 Rs. 125/-
61
Value of a Business
Indicoffee, a popular coffee shop located in a busy shopping mall, is
expected to generate net cash flows of Rs 3 Lacs a year. If the
cash flows increase @ 2.5% pa for the next 50 years, what is the
worth of the coffee shop? (assume discount rate of 15%)
Case-1 Growing Regular Annuity:
3,00,000 1.025
PVGA RA =
10.15 - 0.025 1.15
50
= Rs.23,92,380/
3,00,000 1.025
PVGA RA =
10.15 - 0.025 1.15
50
(1.15) = Rs.27,51,245/
62
31