‘COMPONDIND PERIOD Re100 + 1 100 = press = button * R+200+1% 100, press = button '2° times where m is equal to no of Half years. QUARTERLY R#400 + 1x 100 a fs press = 2 fs nes| MONTHLY R#1200 + 1 x 100 100 FE _ press = button "12" times where nis ‘equal to no of Months. Concept Capsule 10 hace S 2 2 : 5, 5,000 is invested in a Term Deposit Scheme that | TRICK fetches interest 6% per annum compounded | 6+400 +1 x 100 =, -100 = 6.13 % ; quarterly. What will be the interest after one year? | press = button “4” times What is effective rate of interest? , Solution: j te E=(14iy-t =E=(140.015)'— 0613-1 = 0619 0F 6.19% Concept Capsule -11 = Ree im Find the amount of compound interest and effective [TRICK ‘ rate of interest if an amount of Rs. 20,000 is BSD ana) press = button deposited in a bank for one year at the rate of 8% per annum compounded semiannually Solution E=(1+ip— =(1+000472— 0.0816 or 8.16% eee “s Concept 6- Depreciation The depreciation value (¥,) by reducing balance method @ R % p.a is given by: V, =V(4 — }00 = 8.16% |RT eee eer ie Elad Present Value of an Annuity Requi PV of an Annui ity m i ity means the Value of the Annuity at present. It represents the expected Future Cay, Flows, al i it a given rate of interest. Consider the Annuity as under - Present Value Yeai — rend Payments/Receipts (Rs-) 1 5000 Fn f= 5000 + (1.1) = 4545 2 ~5000 = 6000 + (1.1)? = 4132 3 5000 5000 + (1.1)° = 3757 | 4 a 5000 ds 415° 5 5000 | Present Value of Annuity Cash Flow Reiaosseuneys| - | Formula Present Value of a Single Cash Flow | Present Value of an Annuity Regular An. +R)n- 7 Pv tie pie cM | Where n = number of years for which the money is invested | R = rate of return on the investment. | TRICK TO COMPUTE PRESENT VALUE CALCULATOR Annuity Regular Jnnuity is Given & Present Value Asked COMPONDIND PERIOD —_| TRICK 4 R#100 +1 erenmikyePy | ANNUALY press = button “n” times where n is equal to no of years. | 00+ = icAanully @PVGE ae BEE EAN | press = button ‘n" times where 1 Is equal to no of Half years. GT x Annuit press = button ‘n” times where ” is equal to no of Quarters. QUARTERLY ea be R+1200 + 1+ GT * Annuity = PV | press = button ‘7’ if Months. 2 ae nis equal to noo ” times where MONTHLYRe100+1#5,= R#200 +145, =. ‘| R#40041 == R#1200 +1 +=, Concept Capsule -13 Rs. 5,000 is paid every year for ten years to pay sffa loan. What is the loan amount ifinterest rate 5 14% per annum compounded annually? V=AP. (1, i) Here A= Rs. 5,000 n= 10 i=0.14 v= 5000 x P (10, 0.14) = 5000 x 5.21611 = Rs. 26,080.55 Therefore, the loan amount is Rs. 26,080.55 press = button ‘n" ‘| press = button ‘n” times where press = button “n” press = button ‘n” times where n is equal to no of years. = GT (M*) > PV + MRC = Annuity nis equal to no of years "= GT (M*) > PV + MRC = Annuity times where n is equal to no of years RC = Annuity = GT (M*) > PV times where n is equal to no of years TRICK 442100+ 1 +=... = GT * 5000 = 26080.55 press = button “10” times where n is equal 10 n0 of years. Concept Capsule -14 'S borrows Rs. 5,00,000 to buy a house. If he pays ‘equal instalments for 20 years and 10% interest on ‘outstanding balance what will be the equal annual instalment? Solution: ‘We know eqeet P(ni) Here V = Rs. 5,00,000 n=20 i= 10% p.a.= 0.10 Ne ee a at, Coie = Rs, 22222 ip (20, 0.10) = 8.51356 ‘51356 = Rs, 58,729.84 TRICK 10#100 +175, GT (M*) > 500,000 + MRC = 58,729.12 (Approx.) press = button 20" times where n is equal to no of years.qe sume value op money nap. > Value of an Annuity immediate Present value of annuity due/immediate for n years is the same as an annuity regular for (n-1) years plus an initial receipt or payment in beginning of the period. Calculating the present value of annuity due involves two steps. Step 1: Compute the present value of annuity as if it were an annuity regular for one period short. (n- 1) years Step 2: Add initial cash payment/receipt to the step 1 value. RW ol Bi Te ae aa Caan ty Apply Same trick as we Applied for annuity Regular Just Multiply the Final Outcome of Annuity Regular Trick With (1 +r %) Concept Capsule -15 eit F = i Siippose your mom decides to gift you Rs. 10,000 | TRICK | ‘every year starting from today for the next five years. | You deposit this amount in a bank as and when you | 102100+ 1 +=... = GT x 10000 = | Teceive and get 10% per annum interest rate | 37907.86 | ‘compounded annually. What is the present value of this | press = button “10” times where n is equal | annuity? to no of years. Solution: | itis an annuity immediate. For calculating value of the | Since It it Annuity Due: Multiply With annuity immediately following steps will be followed: | (1 + %) Step 1: Present value of the annuity as if it were a | regular annuity for one year less i.e. for four years 17907.86 x (1 + 10 %) =Rs. 10,000 * P (4, 0.10) 7907.86 = 1.1 | = Rs, 10,000 x 3.16987 = 41,698.64 = Rs. 31,698.70 | ‘Step 2: Add initial cash deposit to the step 1 value Rs. | | (31,698.70+10,000) = Rs. 41,698.70 | Concept 9- Perpetuity Perpetuity is a stream of payments or a type of annuity that starts payments on a fixed date and such payments continue forever, i.e. perpetually. Thus, Perpetuity is a constant stream of identical annual ‘cash flows with no end, i.e. up to infinity. Thus, it reflects the expected Present Value of all payments (to be received perpetually The Value of a Perpetuity is finite because receipts that are anticipated far in the future have extremely low PV. Also, because the Principal is never repaid, there is no Present Value for the Principal. Since Perpetuity is a type of annuity which is unending, its sum or Future Value cannot be calculated. Examples: (a) Dividend on irredeemable Preference Share Capital (b) Interest on Irredeemable Debt / Bonds (c) Scholarships paid perpetually from an Endowment Fund, etc.so 5 an Annuity immediate xe Future value of an Annuity due/Annuity immediate = Future value of annuity regular x (1+) where iis the interest rate in decimal. CALCULATOR TRICK TO COMPUTE FUTURE VALUE CT Aur eld Annuity is Given & Future Value is Asked | Future Value is Given & Annuity is Asked ke Apply Same trick as we Applied for annuity Regular Just Multiply the Final Outcome of Annuity Regular Trick With (1 + r %) | Apply Same trick as we Applied for annuity Regular Just Divide the Final Outcome of Annuity Regular Trick With (1 + r %) | Concept Capsule -21 § Z invests RS. 10,000 every year staring from today for next 10 years. Suppose interest rate is 8% per ‘annum compounded annually, Calculate future value ‘of the annuity. Given that (1 + 0.08)19 = TRICK oF a 14=8510041%4 18892500. | 10,000 = 144865.625 Press = button “10-1= 9” times where n is Solution: equal to no of years Step - 1: Calculate future value as though it is an | ordinary annuity. Since It its Annuity Due: Multiply With Future value of the annulty as if iis an ordinary | (4 +r%) | annuity s. 10,000 [een = 144865.625x (1 + 8 %) 8. 10,000 x 14.4865625 1 eae Sci wkceos 8. 1,56,454.875 | ‘Step-2: Multiply the result by (1 +) = Rs, 1,44,865.625 x (1 + 0.08) = Rs, 1,56,454.875 Concept 11- Sinking Fund It's the fund credited for a specified purpose by wa Period at a specified interest rate, Int Basically, it involves determin: ata given rate of interest. Hence, iConcept Capsule -22 Solution: This value can also be calculated by the formula of future value of annuity regular. We know that ADIeA ae 4) 300000 = A | | 300000 = Ax15.9374248 3,00,000, Tas37a2a8 = Rs. 18,823.62 How much amount is required to be invested every | TRICK year so as to accumulate Rs. 300000 at the end of 10 | 1+ =10* 100+ 1*=,=...=GT (Mt) > years if interest is compounded annually at 10%? nag se eee PPRIOK) press = button “10-1=9" times where n is equal to no of years. Concept Capsule -23 How much amount is required to be invested in the beginning of every year so as to accumulate Rs 10,00,000 at the end of 5 years if the effective rate of interest is 12% p.a. Solution: In this case relevant number of years shall be 6 years since in this case 1* annuity is payable in the beginning of 1% year. Future value of an annuity of Rs 1 after 6 years = Oia+o-1 salt + 0.12) - 1] = 8.3333(1.9738 - 1) 3333 (0.9738) =8.115 This is the future value of an annuity of Rs 1 after 6 years. However, in this figure Rs 1 receivable at the end of 6 year is included. Hence in this figure Rs 1 is deducted to arrive at future value of an annuity of Rs 1 for 5.year receivable at the beginning of the year. Therefore, future value of an annuity of Rs 1 for 5 year invested at the beginning of the year =8.115~1 =7AIS Let the amount of an annuity be x’, Therefore, 7.115x = 10,00,000 TRICK 1+=12+100+1x | (M*) > 10,00000 + MRC 157409.73(Approx.) press = button “10” times where n is equal to no of years. Since Itit Annuity Due: Divide With (11%) | =187409.73 + (1 + 12%) | = 140544.40 (Approx.) x= 10,00,000/7.115 = 1,40,548Concept 12-Leasing Decision Leasing is a financial arrangement und asset (lessee) to use the asset for a defined period of time (pare Hee, eae rental) payable over a given period of time. This is a kind of taking Rear Tor yeche (8 sn A company may have to decide whether to obtain a machine either by leasing life) at an annual rent of, say or by purchasing the machine. the asset (lessor) allows the user of th Saat tite riod) for a consideration (leas i ular interve Ih such situation, we find the present value of a lease rentals (as they are Eee hea ‘ver a period of time it can be referred as Annuity) for n years at the interest rate We compare this value with the purchase price and then decide accordingly ESTES eRe eu ea Rus kaka ed Concept Capsule -24 S ¥ ee ABC Ltd. wants to lease out an asset costing Rs. | TRICK 3,80,000 for a five-year period. it has fixed a rental of | PV of Lease Rentals Rs. 1,05,000 per annum payable annually starting from | the end of first year. Suppose rate of interest is 14% per | 14=100+1+ ‘annum compounded annually on which money can be | 1,05000 = 3,60473.50 lnvested by the company. Is this agreement favorable | press = button “5” times where n is equal to the company? to no of Installment. Solution: First, we have to compute the present value ofthe | As We Can See that ‘annuity of Rs. 1,05,000 for five years at the interest PV of Lease Rentals > Purchase Price ‘ate of 14% p.a. compounded annually. Leasing is Not Preferable. The present value V of the annuity is given by | .P (n, i) | = 1,05,000 x P (5, 0.14) .0,5000 x 3.43308 = Rs. 3,60,473.40 | which is greater than the initial cost of the asset and ‘consequently leasing is not favorable to the ima | =GTx Concept 13- Investment Decision Capital expenditure means purchasing an asset (which results in outflows of money) today in anticipation of benefits (cash inflow) which would flow across the life of the investment For taking investment decision we need to compute NET PRESENT VALUE (NPV) NPV = PV of all Cash inflow — PV of all Cash OutflowInvest if Present Value of Cash Inflow < Present Value of Cash Outflow Don't Invest if Present Value of Cash Inflow = Present Value of Cash Outflow Indifference Point it 2 We have to decide to invest but we have to decide in which option to invest? In such situation we will compute NPV under Both the option and the option with higher NPV will be chosen Concept Capsule -25 ‘Amachine can be purchased for Rs. 50000. Machine will contribute Rs, 12000 per year for the next five years. Assume borrowing cost is 10% per annum compounded annually. Determine whether machine should be purchased or not. Solution: The present value of annual contribution V=AP(n,}) = 12,000 x P(6, 0.10) = 12,000 x 3.79079 = Rs. 45,489.48 which is less than the initial cost of the machine. Therefore, machine must not be purchased, Concept Capsule -26 10,000 while another machine with useful life of five years costs Rs. 8,000. The first machine saves labor expenses of Rs. 1,900 annually and the second one saves labor expenses of Rs. 2,200 annually, Determine the preferred course of action. Assume cost of borrowing as 10% compounded per annum. Solution: ‘The present value of annual cost savings for the first machine = Rs. 1,900 x P.(7, 0.10) = Rs. 1,900 x 4.86842 = Rs. 9,249.99, [= Rs. 9.250 ‘A machine with useful life of seven years costs Rs. | TRICK Compute PV of Cash Inflow with PV Trick 10 = 100 +4 Che) 41,2000 = 45,489.44 press = bution °5” times where n is equal to. no of Installment. As We Can See that PV of Cash Inflow - PV of Cash Outflow | NPV<0 | Therefore, Machine must not be purchased TRICK aes Compute PV of Cash Inflow of Machine1 with PV Trick. 10+ 100+ 1+ 1,900 = 9250 (Approx.) .= GT x ress = button “7” times where n is equal to Life of Machine. NPV of Machine 1 PV of Cash Inflow - PV of Cash Outflow 9250-10000 = -750Abond is a debt securit ‘and interest. Bonds ‘fan investor requires a ra Payments iy in which the issuer owes the hol = _ Present Value of interest 40+ 100414 +%, =, =... i 2200 = 8340 (Approx.) press = button “5” times where n is equal to Life of Machine. NPV of Machine 2 PV of Cash Inflow - PV of Cash Outflow 8000-8350 = 350 Since NPV of Machine 1 > NPV of Machine 2 Hence the second machine is preferable Ider a debt and is obliged to repay the principal longer than one year. Present value of Maturity Payments ce Value. Concept Capsule -27 67 497+ 674.972 = 907-125 value of the bond is Rs. value will be calculated by using sanie Trick & Formula as we Discussed i in Concept of Present Le Value of Bond (a)Present Value of interest Payments + (b)Present vaiue of Maturity Payments ue of in Payments 14+100+1+=, =, =, 325.02846 (Approx.) (2) Present value of Maturity Payments = 1000 * 674 = 674,971 =GTx 140= Total (a) + (b) = 999.99 (Approx.)