Chapter 4: Time Value of Money

 Concept of time value of money

 Rationale for time value of money
 Present value and future value
 Discounting and compounding
 Installment and annuity
 Types of annuity
 Simple and compound rate
 Nominal and effective rate
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 Time Value of Money
 Definition: A rationale human being would not value the
opportunity to receive a specific amount of money today
equally with the opportunity to have the same amount at
some future date. Most human beings value the opportunity
to receive money now higher than receive one or two years
from now the same amount. The additional amount that is
required for receiving after a certain time period in future
than the amount received today is known as time value of
money. That is this additional amount is given as value of
time waiting. Actually the percentage change in value of
a certain amount of money for a certain time period
gap is known as time value of money .

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Rationale for Time Value of Money
 Time value of money is existed for the
following reasons:
 Future uncertainty
 Sacrifice present consumption or preference for
higher consumption in future period
 Alternative investment opportunities i.e.
opportunity cost.
 Sacrifice of cash holding preference
 Inflation

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 Terminologies
Present value: The value of today that is
obtained by discounting a future cash flow
or a series of cash flows at desired rate or
opportunity cost of fund as discount rate.
Future value: The amount or value will be
obtained at a certain time point in future of
a cash flow or a series of cash flows by
compounding at expected rate or
opportunity cost over a certain time period.

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 Terminologies
Discounting: The process of finding the
present value of a cash flow or a series of
cash flows by using a given discount rate.
Compounding: The arithmetic process of
determining the final value of a cash flow or
a series of cash flows by using a certain
interest rate

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 Terminologies

 Simple rate: The rate that charged only on

the principal amount for a specific period is
called simple rate.
 Compound rate: The rate that is charged
both on principal and extra amount
earned/paid in previous period is called
compound rate.

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 Terminologies
 Installment: Periodic payments or receipts related to
any transaction or contract are known as installment.
 Annuity: The equal amount of cash flow incurred at
equal time interval is called annuity.
 Annuity due: The annuity under which the cash flow
is incurred at the beginning of each period is called
annuity due.
 Annuity immediate: The annuity under which the
cash flow is incurred at the end of each period is
called annuity immediate.

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 Terminologies
 Perpetuity: The annuity under which the cash flow
is incurred for a infinite period of time is called
Perpetuity..
 Nominal rate: Rate that is stated in an agreement
for transferring fund from one party to another party
is known as nominal rate.
 Effective rate: Rate that is ultimately paid by the
user of fund to the supplier of fund by taking into
consideration of timing frequencies and other
charges is known as effective rate.

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 Problems
1. What will be present value of Tk.800000 will be received
8 years from now at 12% discount rate?

2. Find the present value of Tk.20000, Tk.25000, Tk15000

and Tk.30000 will be received in years 0, 1, 2 & 3
respectively by considering discount/compound rate is 13%.

3. Find the present value of Tk.50000, Tk.28000, Tk.52000

and Tk.40000 will be received in years 1, 2, 3 & 4
respectively by considering discount/compound rate is 13%.

4. You have a choice of receiving 10 payments of Tk.65000

a year, with the first payment to be received one year from
now, or Tk.500000 in cash today. If your opportunity cost is
11%, which would you prefer?
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 Problems
5. You have a choice of receiving 25 payments of Tk.50000 a
year, with the first payment to be received just now, or
Tk.600000 at a time today. If your opportunity cost is 10.5%
which would you prefer?

6. RIC Inc. manufactures and sells green products in the

market. The company receives about Tk.4000000 cash flow
each year from the product selling after all expenses,
including taxes. Samson Ltd has recently offered to buy the
product for Tk.18000000. RIC’s opportunity cost is 7.25%.
Should it sell the product if it thinks its life expectancy is
indefinitely long?

7. What will be future value of Tk.500000 deposited in a bank

after 5 years from now at 5.9% interest rate?
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 Problems

8. Find the future value of Tk.50000, Tk.30000, Tk.45000 and

Tk.60000 will be received in years 0, 1, 2 & 3 respectively by
considering compound rate of 12%.

9. Find the future value of Tk.55000, Tk.20000, Tk.25000 and

Tk.30000 will be received in years 1, 2, 3 & 4 respectively by
considering compound rate of 10.25%.

10. ou have a choice of receiving 8 payments of Tk.150000 a

year, with the first payment to be received one year from now
or Tk.650000 at a time at the end of the total period. If your
opportunity cost is 12% which would you prefer?

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 Problems

11. You have a choice of receiving 16 payments of Tk.35000

a year, with the first payment to be received just now, or
Tk.750000 at a time at the end of the total period. If your
opportunity cost is 10%, which would you prefer?

12. Contractual rate in a loan agreement is 11% and loan

processing fee is 1.25%. What is the effective rate of the
loan if rate is compounded monthly?

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 Problems
13. How much must you invest each year in a sinking fund to
accumulate Tk.500000 after 5 years with benefit rate 10%?
14. You have borrowed Tk.600000 at 15% extra rate of burden and
must pay off the loan in 3 years. Calculate the annual payment
and prepare the loan amortization schedule.
15. Find the present value and future value of Tk.38000, Tk.56000 and
Tk.29000 to be received in years 0, 1 & 2 respectively with
10.25% opportunity cost.
16. Find the present value and future value of Tk.45000, Tk.60000 and
Tk.90000 to be received in years 1, 2 & 3 respectively with
10.50% opportunity cost.

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 Problems
17. Find the present value and future value of Tk.53000 to be received
per year/yearly/annually/ per annum for next 12 years with 10.50%
opportunity cost.
18. Find the present value and future value of Tk.75000 to be received
per year/yearly/annually/ per annum for next 20 years where cash
flows will be beginning/starting/instantly/immediately with 9.75%
opportunity cost.
19. Find the present value and future value of Tk.75000 to be received
each quarter for next 20 years where cash flows will be
beginning/starting/instantly/immediately with 10% opportunity
cost.
20. Find the present value and future value of Tk.20500 to be received
each quarter for next 20 payments where cash flows will be
beginning/starting/instantly/immediately with 11% opportunity
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cost.
21. Determine the periodic deposit for accumulating Tk.250000, 8
years from now where deposits will be immediately that will earn 6%
compound benefit rate under the followings:
(a) Half-yearly (b) Quarterly (c) Monthly
22. Determine the periodic repayment against loan Tk.1250000,
borrowed for 9 years @ 11% compound rate under the followings:
(a) Half-yearly (b) Quarterly (c) Monthly

23. Given, Period: 1---------10

Cash flows: Tk.42000 i/k/r = 0.1025 PV=? FV= ?
24. Given, Period: 0---------15
Cash flows: Tk.53000 i/k/r = 0.1025 PV=? FV= ?

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