Time Value of Money

09-02-2020 BM 209 Finance Management by Dr Naim R Kidwai 1

 Time value of money
• In late 1970s, Americans experienced inflation in the range of 17%
• A rupee today has a lower value (purchasing power) in future , due to inflation
• There is more to time value of money than the force of inflation.
• if no inflation, a rupee today has the same purchasing power as a rupee one year later.

Rate of return: If you have an opportunity to lend Rs 1,000/- to a business at a 10% interest
yearly then at year end you will receive a payment of Rs 1,100/- when the loan is paid off
then rate of return in this opportunity is 10%. If you have to pay 10% tax on interest earned,
then effective rate of return reduces to 9%.
Expected Rate of return is rate of discounting/incrementing for analyzing series of cash flows
overtime
Rate of return is rate of discounting and should be higher than expected inflation
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 Future value of Investment: FD
Let r is interest rate fraction per time slot and n is number of completed time slots
Let R=1+r, where r is interest rate in fraction
then future value FV FD deposit
FV =PV.Rn
where PV is present value
PV =FV/ Rn 0
Period
1 2 3

Maturity

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 Future value of Investment :RD
Let ‘A’ amount is deposited periodically for n periods at a interest rate of r (in fraction)
per time slot
Let R =1+r , where r is interest rate in fraction RD deposit
Then at the end of n periods
FV =A.Rn +A.Rn-1 +………+A.R
=A R +A R2 +………+ A Rn 0
Period
1 2 3
FV =A.R.[Rn -1] /(R-1)
where A is periodic deposit or annuity
Maturity

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 Time value: Loan
Let ‘E’ amount is EMI for n periods for a loan Amount of PV at a interest rate of r (in fraction)
per time slot
Let R =1+r
EMI deposit ‘E’
Then at the end of n periods
PV Rn =E.Rn-1 +E.Rn-2 +………+ E
=E+E R +………+ E Rn-1 Period
0 1 2 3 4
n
=E[R -1] /(R-1)
Thus
Loan disbursed
E= PV Rn [R-1]/ [Rn -1]

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 Effect of Time Value: Example
Project A Project B
Discounting PV of Discounting PV of
Year Outflows Inflows Year Outflows Inflows
factor @ 10% In flows factor @ 10% In flows
0 500 0 500
1 0.9091 0 1 0.9091 0
2 0.8264 0 2 0.8264 0
3 100 0.7513 75.13 3 300 0.7513 225.39
4 200 0.6830 136.60 4 250 0.6830 170.75
5 500 0.6209 310.45 5 225 0.6209 139.70
Total 500 800 522.18 Total 500 775 535.84

• Without considering Time value Project A have better return

• Project B have more value after considering time value.

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 Effect of Time Value: Example

If r is discounting/ incrementing rate per period in fraction

(r in percentage can be converted into fraction by dividing by 100)
Then discounting/incrementing factor R =1+r
• To find equivalent future value (after n periods) for a amount
multiply by Rn
FV = PV. Rn
• To find equivalent present value (before n periods) for a amount
divide by Rn
PV = FV / Rn
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 Thank You

Contact
Email: naimkidwai@gmail.com
https://nrkidwai.wordpress.com/
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