Time Value of Money

The simple concept of time value of money is that the value of

the money received today is more than the value of the same
received after a certain period. In other words , money
received in the future is not as valuable as money received
today. The sooner one receives money the better it is.

The present worth of a rupee received after some time will be

less than a rupee received today. Since a rupee received today
has more value , rational investors would prefer current receipt
than future receipts. This phenomenon is referred to as time
preference of money
Reasons for Time Preference of Money

(i) An individual can never be certain of getting cash inflows in

future and hence he will like to receive money today instead of
waiting for the future
(ii) People generally prefer to use their money for satisfying
their present needs in buying more food, or clothes or another
car , than deferring them for future.
(iii) Money has time value because of the opportunities
available to invest money received at earlier dates at some
interest or otherwise to enhance future earnings
Techniques of Time Value of Money

1. Compounding Technique or Future

Value Concept

2. Discounting Technique or Present Value

Concept
 1. Compounding Technique or Future value
Concept
Compounding technique is the process of determining the future value of an investment
made today. Under this process, interest is compounded when the amount earned on an
initial deposit (the initial principal) becomes part of the principal at the end of the
first compounding period.
For example, If a person invest Rs. 100 today at interest rate of 10 % p.a, after one year he
will receive Rs. 110. For waiting one year ,he will receive Rs. 10 extra along with initial
amount which is 100+10= 110.
For calculating Future value of a present value following formula is used

Where FV= Future value

PV= Present Value
I = rate of interest
n= Time period
 Compounding Technique
Problem 1 .A person invests Rs 10,000 now , how much amount he will receive after 5
years if rate of interest is 10 % per annum.
Solution: In above question Rs 10,000 invest by a person
Present Value (PV) = Rs. 10,000
Time period (n) = 5 years
Rate of Interest (i) = 10 % which is 10/100=0.10
To find out the amount ,he will receive after five years following future value formula
will apply

FV= 10,000 x 1.611= Rs.16,110

Hence the person will receive Rs.16,110 after 5 years
 Compounding Technique
Problem 2 A person keeps Rs.100,000 in a scheme for 10 years , how much
amount he will receive if rate of is 12% per annum.
Solution : He keeps Rs 100,000 now means
Present Value (PV) is Rs 100,000
Time period (n) is 10 years
Rate of Interest (i) is 12% which can be 12/100= 0.12
Total amount the person will receive after 10 years can be calculated by using
following formula

FV= 100,000 x 3.106 = Rs. 310,600

Hence the person will receive Rs. 310,600 after 10 years
 Problems on Series of In equal investments
Problem 3 A person invests Rs. 1,000, Rs. 2,000, Rs. 3,000 , Rs. 4,000 and
Rs.5,000 at the end first year, second year, third year, fourth year and fifth year
respectively . If rate of interest is 10% p.a , how much amount he will receive at the
end fifth year.
Solution : In this type of problem , first we need know about , what is the time
period for different investment . Here all the investment made at the end of the
year.
Rs.1000 invested at the end of first year , means Rs. 1000 will be compounded
for rest four years
Rs. 2000 invested at the of second year , means Rs. 2000 will be compounded
for rest 3 years
Rs. 3000 invested at the of third year , means Rs. 3000 will be compounded for
rest 2 years
Rs. 4000 invested at the of fourth year , means Rs. 4000 will be compounded for
rest 1 year
Rs. 5000 invested at the of fifth year , means Rs. 5000 will not be compounded
because it is given on the date maturity , just it will added
 Cont.d
It can be written in following ways
Investment Time period
Rs. 1,000 4 years
Rs. 2,000 3 years
Rs. 3,000 2 years
Rs. 4,000 1 year
Rs. 5,000 0 year
Rate of interest (i) is given 10% which is 10/100= 0.10
The future value after 5 years can be summation of all the future value calculated in
following ways
PV Rate of Interest (i) Time period (n) FV
1000 10% 4 years = 1000 x 1.464= 1464
2000 10% 3 years = 2000 x 1.331= 2662
3000 10% 2 years = 3000 x 1.210= 3630
4000 10% 1 year = 4000 x 1.100= 4400
5000 10% 0 year = 5000 x 1 = 5000
Total 17,156
 Doubling Period
Doubling period is the period  in which the
investment is doubled
There two formulas to calculate doubling
period
1. Rule of 72
Doubling Period = 72/ Rate of Interest
2. Rule of 69
Doubling Period = 0.35+(69/Rate of Interest)
 Example
Problem 4 If you deposit Rs. 5,000 today at
6 % rate of interest p.a , in how many years
will this amount double?
Solution: According to Rule of 72
Doubling Period = 72/ Rate of Interest
= 72/6 = 12 years
According to Rule of 69
Doubling Period= 0.35 + (69/6) = 0.35+11.50
= 11.85 years
 Multiple Compounding Period
In many cases , interest may have to be compounded more
than once in a year . Interest may be calculated semi-annually,
quarterly or monthly.
In case of multi-compounding period the following formula
will is applied

Here FV = Future Value

PV = Present Value
i= Rate of Interest
n= Time period
m= Number of times of compounding per year
 Example
Problem 5 Calculate the compound value of
Rs.10,000 at the end of 3 years at 12% rate of interest
is calculated on (a) half yearly basis, and (b)
quarterly basis.
Solution : (a) When interest calculated half yearly basis
PV= Rs.10,000
i= 12% which is 12/100=0.12
n= 3years
m= 2 (because half yearly means two times in
a year )
 Cont..d

FV= 10000x 1.419= 14,190

(b) When interest is calculated quarterly basis
Only ‘m’ will be 4 because one years having 4 quarters, so
interest will calculated 4 time in a year

FV = 10000x 1.426= 14,260

 Annuity
 A series of equal payments lasting for some
specified duration is called as Annuity . The LIC
premium paid is an example Annuity
The equal payments can be made at the beginning
of the period or end of the period
 When the amount is paid at the beginning of the
period , the annuity is called an Annuity Due
 When the amount is paid at the end of year the
period , the annuity is called Deferred Annuity
 Example on Annuity deferred

Problem 6 Rohan deposits Rs. 2,000 at end of

every year for 5 years in his saving account
paying 5 % interest compounded annually.
How much money he will receive at the end
of 5th year?
Solution : Here Rs. 2000 deposited at end of
every year . To calculate future value after 5
year following future value formula will be
applied
 Cont..d
Present value is Rs.2,000, rate of interest is 5% which is 5/100=
0.05, time period is different.
PV n i FV
2000 4 years 0.05 =2000x 1.216 = 2432
2000 3 years 0.05 = 2000x 1.158 = 2316
2000 2 years 0.05 = 2000 x 1.103 = 2206
2000 1 year 0.05 = 2000 x 1.050 = 2100
2000 0 year 0.05 = 2000 x 1 = 2000
Total Rs.11,054
 Example on Annuity due
Problem 7 Rohan deposits Rs. 2,000 at beginning
of every year for 5 years in his saving account
paying 5 % interest compounded annually. How
much money he will receive at the end of 5th year ?

Solution : Here Rs. 2000 deposited at the beginning

of every year . To calculate future value after 5 year
following future value formula will be applied
 Cont..d
Present value is Rs.2,000, rate of interest is 5% which is
5/100= 0.05, time period is different.

PV n i FV
2000 5 years 0.05 = 2000x 1.276 = 2552
2000 4 years 0.05 = 2000x 1.216 = 2432
2000 3 years 0.05 = 2000 x 1.158 = 2316
2000 2 years 0.05 = 2000 x 1.103 = 2206
2000 1 year 0.05 = 2000 x 1. 050 = 2100
Total Rs.11,606
Alternative Method by using Annuity
Table (Annuity Deferred)
Problem 6 Rohan deposits Rs. 2,000 at end of every
year for 5 years in his saving account paying 5 %
interest compounded annually. How much money he
will receive at the end of 5th year?
Solution: By using Annuity Compound factor table:
Future value can be calculated by using following
formula, when investment is made at the end of the year

Where FV= Future Value, PV=Present Value

ACF= Annuity Compounding Factor
 Cont..d
PV= Rs.2000, i=5% , n= 5 years

You have to Annuity Compound

Factor Table 5% column of 5year row the
value is 5.526. So Future Value is
FV= 2000 x 5.526 = Rs. 11,052
Alternative Method by using Annuity
Table (Annuity Due)
Problem 7 Rohan deposits Rs. 2,000 at beginning
of every year for 5 years in his saving account
paying 5 % interest compounded annually. How
much money he will receive at the end of 5th year ?
Solution: By using Annuity Compound factor table:
Future value can be calculated by using following
formula, when investment is made at the beginning
of the year
 Cont..d
Present Value (PV)= 2000, i=5%, n=5years

FV=2000 x 5.526 x 1.05= Rs.11,605

 2. Discounting Technique or Present
Value Concept

 Discounting is the process of determining

the present value of a payment or a stream of
payments that is to be received in the future.

 Present Value concept is exactly opposite of

compound value or future value. Present Value
shows what the value today of some future
sum of money.
 Formula to calculate Present Value

Where PV= Present Value

FV= Future Value
i = Rate of Interest
n = Time Period
Example : Calculate the Present Value of Rs.
100,000
to be received after 5 years , if rate of interest is
6% p.a.
 Solution
Given Future Value(FV) is Rs. 100,000
Rate of Interest (i) is 6% which is 6/100= 0.06
Time Period (n) is 5 years
Present Value :

PV = 100,000/1.338= 74,738
 By using Present Value table
The Formula to Calculate Present Value is :

PV= Present Value

FV= Future Value
= Discounting Factor
 Same Example by using Present Value
Table
Calculate the Present Value of Rs. 100,000
to be received after 5 years , if rate of interest is
6% p.a.
Solution: Given Future Value (FV) = Rs. 100,000
Time period (n) = 5 years
Rate of Interest (i) = 6% = 6/100= 0.06

PV = 100,000 x 0.747 = Rs. 74,700

 Example 2
A person wants to receive Rs.200,000 after 6 years. How much
money he will keep today if rate of interest is 10% p.a.
Solution: Given Future Value (FV) = Rs.200,000
Time period (n) = 6 years
Rate of interest (i) = 10% = 10/100= 0.10
Present Value can be calculated by following
formula:

PV = 200,000 x 0.564= Rs.112,800

 Example 3
Calculate Present value of the following cash
flows assuming discounting rate 8 % p.a.
Year Cash flows
1 Rs. 10,000
2 Rs. 20,000
3 Rs. 10,000
4 Rs. 5,000
 Solution
Here Future value after different time period is given. To
determine the present value the future cash flows should be
discounted at discount rate (8%) and added.
To calculate the Present Value the formula is:
FV n i PV
10,000 1 8% 0.926 10,000x0.926= 9,260

20,000 2 8% 0.857 20,000x0.857= 17,140

10,000 3 8% 0.794 10,000x0.794= 7,940
5,000 4 8% 0.735 5,000x0.735= 3,675
Rs. 38,015