Time Value of Money

Abhinav Rajverma
Contact: +91-81281-95751
 Time Value of Money
A rupee today is worth more than a rupee in the future.
Basic Concepts
• Timelines & CFs
• Nominal/Effective/Periodic Rates
• Compounding
• PV/FV of lumpsum
• PVF & FVF
• Annuities/Perpetuities
• Growing Perpetuity

Excel Functions
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 Excel Functions

PV Function
Syntax = PV (rate, nper, pmt, [fv], [type])

FV Function
Syntax = FV (rate, nper, pmt, [pv], [type])

NPV Function
Syntax = NPV (rate, value1, value2…..)

PMT Function
Syntax = PMT (rate, nper, pv, [fv], [type])

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 Modeling for Time and Risk

CFs Modeling
• Even Timeline
• Uneven
Time-difference between CFs
• Even
Timeline
• Uneven
Modeling for “r”
• Constant per period Equivalent Rate
• Not Constant - Bootstrapping

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 Timeline

T0 T1 T2 T3
r = i%
CF0 CF1 CF2 CF3

 Timeline takes care of CFs

 Timeline takes care of time-differences

“Modeling for risk (r)”: Find equivalent rate (r) for one period
Note: Time period may be of any time duration
Always draw a timeline to visualize the timing of CFs

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 What is a rate (r) ?

What is rate (TVM)

 Returns on investments
Interest Rate
Bond Yield
Dividend Yield
Capital Gain Yield
 Discount Rate (costs)
Cost of Equity
Cost of Debt
WACC

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 Present Value (PV)
What is ? How is value determined?
Subjective
Objective
Valuation (or CFs)
1. No Uncertainty – Complete Solution
2. Uncertainty – Partial Solution (approximation)
The Value is determined the same way, but how?

INR 2000 + USD 50 = ??

 Can we add ??: first convert into a common currency
 Same principle for CFs with different dates
 CFs can be converted to PV

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 Net Present Value (NPV)
Net of initial cost of investment
Captured by date 0 cashflow
PV (of future CFs) minus initial investment
Cashflows (CFs)
 CFs can be positive or negative

Illustration: Assume, you invest ₹1000 today that earns CFs

of ₹500 and ₹700 in year 1 and year 2, respectively. What is
the net value of the project today?

Discount Rate?

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 NPV Example
IRMA pays an annual electricity bill of ₹10,00,000. ABC
Calibrations offers to install a circuit system for ₹2,50,000 that
will reduce bills by ₹1,00,000 per annum for the next three years.
Is this a good investment? Assume the interest rate is 10%.

Year 0 1 2 3
CFs -250,000 100,000 100,000 100,000

PVF 1 1/(1.1)^1 1/(1.1)^2 1/(1.1)^3

CFs -250,000 90,909 82,645 75,131

₹ (-) 1,315

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 Equivalent Periodic Rate Calculation

FV at time T is same (equal)

=

Þ=
Þ=

Þ=

m & n are number of period(s) per year

 & are effective periodic rates

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 Power of Compounding
𝐴 𝑇 = 𝐴 0 (1+ 𝑅/ 𝑚)𝑚𝑇
Compounding Value of 100
frequency (in 1 year at 10% nominal)
Annual (m=1) 110.000
Semi-annual (m=2) 110.250
Quarterly (m=4) 110.381
Monthly (m=12) 110.471
Weekly (m=52) 110.506
Daily (m=365) 110.516

Continuous Compounding ??
 FV of a lumpsum

FVF =
PVF = 1/FVF =

Example: Assume, you invest ₹1000 today that earns a return of

10 percent, compounded annually. How much will you receive
after year 1, year 2, and year 3?

Year Beginning Yearly Total Ending Direct Method

Amount Interest Interest Amount
1 1,000 100 100 1,100 1,000 * (1+0.1)1
2 1,100 110 210 1,210 1,000 * (1+0.1)2
3 1,210 121 331 1,331 1,000 * (1+0.1)3

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 Doubling Period
Rule of 72:
Doubling period = 72/Interest Rate
Rule of 69:
Doubling period = 0.35 + 69/Interest Rate

Example: Assuming interest rate of 9%, calculate the

doubling period.

Rule of 72: Doubling period = 72/9 = 8.00 years

Rule of 69: Doubling period = 0.35 + 69/9 = 8.02 years

* Rule of 69 offers more accurate result.

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 Excel Function: PV and FV

PV Excel Function
Syntax = PV (rate, nper, pmt, [fv], [type])
Example 1: You have an option of selecting either of the three
income. (1) ₹1000 after 2 years (2) ₹1080 after 3 years, and (3)
₹1200 after 5 years. Assuming a return of 10 percent,
compounded annually. What will be your selection?

FV Excel Function
Syntax = FV (rate, nper, pmt, [pv], [type])
Example 2: Assume, you invest ₹1000 today that earns a return
of 10 percent, compounded annually. How much worth is your
investment after year 2, year 3, and year 5?

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 Annuity
An annuity is a series of identical payments at equal intervals.

Ordinary Annuity
0 1 2 3
i%

1000=PMT 1000 1000

Annuity Due
0 1 2 3
i%

1000=PMT 1000 1000

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 Annuity Formula
An annuity is a series of identical payments at equal intervals.

+ + ……. +

+ …….

𝐶
𝑟 ∗ 𝑃𝑉 = 𝐶 − 𝑇
(1 +𝑟 )

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 Example: Ordinary Annuity (1/2)
Problem: Find the PV of a 3-year ordinary annuity of Rs.
1000 at 10%?

0 1 2 3
10%

1000 1000 1000

909.1
826.4
751.3
2486.9 = PV

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 Example: Ordinary Annuity (2/2)
Problem: Find the PV of a 3-year ordinary annuity of Rs.
1000 at 10%?
Using Annuity Formula:

= 2486.9

Using Excel Function:

Syntax = PV (rate, nper, pmt, [fv], [type])
PV = 2486.9

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 FV of Ordinary Annuity (1/2)
Problem: Find the FV of a 3-year ordinary annuity of Rs.
1000 at 10%?

0 1 2 3
10%

1000 1000 1000

1100
1210
FV = 3310

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 FV of Ordinary Annuity (2/2)

Q. Find the FV of a 3-year ordinary annuity of Rs. 1000 at 10%?

Using Annuity Formula:

FV = 1000 * = 3310
Using Excel Function:
FV = FV (rate, nper, pmt, [pv], [type]) = 3310

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 Perpetuity
A perpetuity is a series of identical CFs forever at equal intervals.

+ + …….

+ …….

𝑟 ∗ 𝑃𝑉 =𝐶
𝑷𝑽 =𝑪 /𝒓
*Dividend Discount Model (DDM) uses the concept of a perpetuity

Growing Perpetuity ??
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 Uneven CFs
Q. Find PV of the CFs assuming expected return of 10% per period.

0 1 2 3
10%

-50 100 75 50

Solution:
• Get PV of all the CFs
• Add all the PVs to get NPV of the CFs

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 Retirement problem
Scenario Solution
1. Retirement in 35 years
2. Deposit Rs. 25,000 every year 1. Time Period = 35 yrs
into an Index fund
2. PMT = Rs. 25,000
3. Returns expected = 12.1%
annually
3. Interest Rate = 12.1%
4. How much will you have on
retirement after 35 years?
4. FV = ? = Rs. 1,10,48,533
5. How much total cash will you
have to outlay to accumulate 5. Total cash outlay = 25,000 *
that much? 35 = Rs. 8,75,000
6. Calculate the lumpsum fund 6. Lump sum fund (PV) =
required to generate same FV*PVF = 1,10,48,533*
amount in 35 years. 0.018357 = Rs. 2,02,819
 Takeaways

Time Value of Money

Time and Money
Excel Functions: PV, FV, PMT, RATE, etc.
Annuity Concepts
Perpetuity Concepts
Retirement Planning

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Thank You
for
Your Time

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