Prepared by

Priyanka Gohil
M.com, M.Phil.
 Financial decisions affect the firm’s cash flow in different time periods

Ex. Fixed assets is purchased

Borrow funds from Bank
Issue equity shares.

Sound decision making requires that the cash flow should be logically comparable.
 Time Value of Money

Time value of money is the

value of a unit of money at
different intervals.
Time preference of Money

Since a rupee received today is

more than its value received at
a later date.
 There are other reasons
for individual’s time
preference for money.

sk
ri Preference for
consumption
opportunities
Investment
Computing the Time Value

Compounding
Technique:

Discounting
Technique:
Compounding or Future Value

In compounding
approach we
convert present
amounts into future
amounts.
Discounting or Present Value

In discounting
approach we
convert the
future value to
present sums.
A) Compounding or Future Value

Future value of Money can be calculated by

Simple Interest
Compound Interest
 Simple Interest

Principle Time

Rate
Interest . . .

Interim Value . . .
Interest . . .

Interim Value . . .
Interest . . .

Interim Value . . .
The Power
of Simple
Interest
Compound
Interest
Compound Interest . . .

For the first

compounding period
interest is
computed in the
same way as simple
interest.
Compound Interest . . .

Compute interest
on the original
principal plus the
interest from
step 1.
Compound Interest . . .

The process is
repeated until
the full period of
time is reached
Interest . . .

Interim Value . . .
Interest . . .

Interim Value . . .
Interest . . .

Interim Value . . .
There simply
has to be an
easier way to
do this!
Yes there is!
1. Future Value of a Single Flow (lump sum)

Simply use
this formula.

f n  P (1  i ) n

Where,
fn= Future value of the
initial cash flow
P= Initial cash flow
I= Annual rate of interest
N=Life of investment
 Fn=P(1+i) n

Fn =1000(1+0.12)3
=1000 (1+0.12) (1+0.12) (1+0.12)
=1404.93

Or
=PV*FVIF(12%, 3y)
=1000*1.404(from the tables)
=1404
 Doubling period

“How long will it take for the amount invested to double

for a given rate of interest.”
‘Rule of 72’ This rule states that the period within
which the amount doubles is obtained by dividing 72
by the rate of interest.
Ex. Rate of interest is 10%.
Doubling period is 72/10, 7.2 years.

‘Rule of 69’ a much accurate way of calculating

doubling period is the ‘rule of 69’, which is expressed
as 0.35+69/interest rate.
Ex. Rate of interest is 10%.
0.35+69/10
Doubling period is 7.25 years
 Increased frequency of compounding

That’s the number of What do we mean

times interest is by frequency of
compounded in one year. compounding?

So, annual
compounding is once
per year. Right?
Divide “i” by the frequency
of compounding.

fn  P (1  i ) n

Multiply “n” by the

frequency of compounding.

Fn= P(1+i/m) m*n

Where,
fn= Future value of the initial cash flow
P= Initial cash flow
I= Annual rate of interest
m= no. Of times compounding is done
during a year
n= No. of years for which compounding is
done
 For example: Under the Abc Bank’s Cash
Multiplier Scheme, deposits can be
made for periods ranging from 3
months to 5 years.
1. Every quarter interest is added to the
principal.
2. Every half yearly interest is added to
the principal.
The applicable rate of interest is 6 %.
What will the amount of Rs. 1000 today
be after 2 years?
2 Future Value of a Series of Cash Flows

Mr. Manoj invests Rs. 500, Rs. 1000, Rs. 1,500, Rs. 2,000
and Rs. 2,500 at the end of each year. Calculate the
compound value at the end of 5 years, compounded annually,
when the interest charged is 5% p.a.

3 Future Value of an Annuity

(i) Mr.Ramesh deposits Rs. 2,000 at the end of every year
in his saving account, paying 5% interest compounded
annually. Determine the sum of money, he will have at the
end of the 5th year.
(ii) Calculate the value of an annuity flow of Rs. 5000
done on a yearly basis for 5 years, yielding an
interest of 8% p.a.
B) Discounting or Present Value
In discounting
approach we
convert the
future value
to present
sums.
 1. Present Value of a Single Flow

PV  FVn /(1  i ) n

Where,
PV= Present value
I= Annual rate of interest
N=Life of investment
 Ex 1. If Mr. X depositor, expects to get Rs. 100 after
one year, at the rate of 10% what should be the amount
he has to forego at present.

Ex. 2 Mr.X wants to find the present value of Rs.

2,000 to be received 5 years from now, assuming 10
percent rate of interest.
2. Present Value of Annuity

Ex.: Calculate the present value of an annuity of

Rs.1000 received annually for 5 years, when
discounting factor is 10%.
3. Present value of perpetuity

P= A/I
Where, A is Perpetuity
I is Interest rate
EX. If the principal of college wants to
institute a scholarship of Rs.10,000 to a
meritorious students in finance every
year, find out the present value of
investment which would yield Rs.10,000
in perpetuity, discounted at 10%.
EX. An investor expects a perpetual sum
of Rs. 500 annually from his investment.
What is the present value of his
investment. What is the present value
of this perpetuity if his interest rate is
10 percent?
 4. Present value of an uneven periodic sum

PV=A1/(1+i)+A2/(1+i)2+A3/(1+i)3+………+An/(1+i)n
OR
PV= A1 PVIF (i, 1) +A2 PVIF (i,2) +A3 PVIF
(i,3)+ A4 PVIF (i,4)+………… An PVIF (i,n)

Ex. An investor will receive Rs. 10,000,Rs. 15,000, Rs.

8,000, Rs. 11,000 and Rs. 4,000 respectively at the
end of 5 years. Find out the present value of this
stream of uneven cash flows, if the investor's interest
rate is 8%.
5. Capital Recovery Factor

Suppose you have borrowed a 3 year loan of Rs.

10,000 at 9 percent from your employer to buy a
motorcycle. If your employer requires three equal
end-of-year repayments, then the annual installment
will be,

10,000 = A* PVFA(3, 9%)

10,000= A*2.531
A= 10,000/2.531
= 3,951
Ex. A loan of Rs. 1,00,000 is to be
repaid in 5 equal annual installments. If
the loan carries a rate of 14% p.a., what
is the amount of each installment?