TIME VALUE OF

MONEY
LEARNING OBJECTIVES

 Introduction
 Types of Cash flows
 Future Value of a Single Cash Flow
 Multiple Flows and Annuity
 Present Value of A Single Cash Flow
 Multiple Flows and Annuity
 Growing Annuity
 Perpetuity and Growing Perpetuity
 loan amortization schedule
WHY IS INTEREST PAID
1. Time value of money
2. Opportunity Cost
3. Inflation
4. Liquidity Preference
5. Risk factor
SIMPLE INTEREST
I = Pnr
Maturity = P + I
Illustration:
1. Sachin deposited Rs.1,00,000 in his bank for 2 years at simple interest rate of 6%.How much
interest would he earn? How much would be the final value of deposit? =1,12,000
2. What sum of money will produce Rs.28,600 as an interest in 3 years and 3 months at 2.5% p.a.
simple interest? 28,600=X*3.25*2.5% X =3,52,000
3. In what time will Rs. 8,000 amount to Rs. 8,820 at 10% per annum interest compounded half-
yearly?
8820 = 8000 (1.05)^(2*1)
2 = 2n
N=1 year
COMPOUND INTEREST
An = P ( 1 + i)n
Interest = An - P
In what time will Rs.85,000 amount to Rs. 1,57,675 at 4.5 % p.a.
Interst = 1,57,675-85,000=72,675
1. 85,000 *4.5%*N=72,675
N = 19 Years

Illustration:
8820 = 8000 (1.05)^2n
1.1025= 1.05^2n
2n = 2
N=1
1. Find the rate percent per annum if Rs. 2,00,000 amount to Rs. 2,31,525 in 1½
year interest being compounded half-yearly.
2,31,525 = 2,00,000(1+I)^3
1.1576= (1+i/2)^3
1.05^3=1.1576
Interst rate = 10%
Rs. 2,000 is invested at annual rate of interest of 10%. What is the amount after
twoyears if compounding is done (a) Annually (b) Semi-annually (c) Quarterly (d)
monthly
2000(1.1)^2= 2420
2000(1.05)^4=2431.012
2000(1.025)^8=2436.8058
COMPOUND INTEREST
4. A person opened an account on April, 2001 with a deposit of ` 800. The account paid 6%
interest compounded quarterly. On October 1 2011 he closed the account and addedenough
additional money to invest in a 6 month time-deposit for ` 1,000, earning 6%compounded
monthly.
(a) How much additional amount did the person invest on October 1?
(b) What was the maturity value of his time deposit on April 1 2012?
(c) How much total interest was earned?
Given that (1 + i)n is 1.03022500 for i=1½ % n = 2 and (1+ i)n is 1.03037751 for i = ½ % and
n = 6.
COMPOUND INTEREST
5. Mr. Dinesh wants to invest Rs. 80 lacs in a scheme in Bank of England where he deposits
the amount for one year @ 12.5% simple interest. All the other banks offer an interest rate of
12% p.a. He has enquired deposit application forms of 4 banks, particulars of which are as
follows —
Bank A: Interest will be credited on half-yearly basis.
Bank B: Interest will be credited on quarterly basis.
Bank C: Interest will be credited on monthly basis.
Bank D: Interest will be credited on weekly basis.
If Mr. Dinesh cares for every extra rupee, which Bank will be preferred? What should be the
minimum rate Bank B should offer to attract Dinesh’s deposit? If Bank A agrees to credit
interest at continuous compounding basis, what will be return for Mr. Dinesh? (e0.12 =
1.127497)
CALCULATION OF PRESENT
VALUE OF CASHFLOWS
1. Calculate the present value of future cash flows (Discounting factor 10%)

Particulars Zeta Meta

Investment 15,00,000 11,00,000
Cash Inflows    
Year 1 6,00,000 6,00,000
Year 2 6,00,000 4,00,000
Year 3 6,00,000 5,00,000
Year 4 6,00,000 2,00,000