TIME VALUE OF MONEY

Dr. Ajit Joshi

Chartered Accountant
Associate professor – Finance
Prin.L.N.Welingkar Institute of
Management Development and Research
What is Finance?
FINANCE IS ALL ABOUT TIME VALUE OF MONEY
• People prefer Cash over Promise Because…
• Transaction Motive
• Speculation Motive
• Precautionary Motive
• Default Risk!
• Compensation for foregoing cash is the fall in its value

1000 Rs after 1 Year is NOT 1000 Rs today……….

Time Value of Money
• If I borrow today, I have to repay higher tomorrow…
Compounding!

Rs 1000 Borrowed

Rs 1100 Repaid
Discounting…
• So… If I am receiving Rs 1000 at the end of the Year, it
won’t be same as Rs 1000 today, but LESS!

Today?

Rs 1000 Received

𝐹𝑢𝑡𝑢𝑟𝑒𝑉𝑎𝑙𝑢𝑒
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒= 𝑡h

(1+ 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒)𝑛 𝑦𝑒𝑎𝑟

𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒=𝐹𝑢𝑡𝑢𝑟𝑒𝑉𝑎𝑙𝑢𝑒×𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝐹𝑎𝑐𝑡𝑜𝑟

𝑃𝑉 =𝐹𝑉 × 𝑃𝑉𝐹 𝑟 % ,𝑛 𝑡h
𝑦𝑟
Present Value…
• Any future cash flow can be discounted at given interest rate to
arrive at it’s present value. This is done by the formula .
Because, We know…

(Compounding Interest Formula)

• is known as PVIF or PVF (Present Value Factor)
• PV = CF × PVF
• In this way all the inflows and outflows of future are discounted
to their present value.
Uniform Cash Flows
• When a cash flow per annum is same, there is a shortcut method to find PV…
• We know…
P.V. = F.V. = CF × PVIFn,r

Where n = the year in which Flow happens and

r = Discount Rate
• Thus, suppose if we have flows for 3 years,
P.V. = (CF1 × PVF1st,r ) + (CF2 × PVF2nd,r )+ (CF3 × PVF3rd,r )
• However, if the Flows are constant or same, say Q
P.V. = (Q × PVF1st,r ) + (Q × PVF2nd,r )+ (Q × PVF3rd,r )
= Q * (PVF1st,r + PVF2nd,r + PVF3rd,r )
Here,

PVFA3,r = (PVF1st,r + PVF2nd,r + PVF3rd,r )

Hence,

PV = Q × PVFA3,r

In words,

Present Value of Uniform Cash Flows ‘UCF’ for ‘n’ number of years at discount
rate ‘r’ is given by

PV = UCF × PVFAn,r
Discounting – Case Study
Salman has put his child in the first standard and plans to pay his fees
each year, of Rs. 15000, for next 10 years, out of an investment that he
would make right now. At the end of 10th year, he is expecting the
investment to generate Rs. 100000 for college admission. How much
should he invest presently, if the bank is offering 6.35%?
PERPETUITY
• Indefinite and uniform cash flows

• Scholarship, prize money

• Cash Flow growing at a Uniform rate

Perpetuity – Trial Sum
Abhishek wants to institute a Scholarship in the name of Harivanshrai,
which would be Rs. 5000 per year. If the SBI is willing to offer him 8%
p.a. perpetuity, how much is he required to invest?
Solution

Perpetuity =

Amount to be invested = = Rs. 62,500

Growing Perpetuity – Trial Sum
Sachin has decided to donate a certain sum, so that every year Rs.
1,00,000 can be paid as a Prize Money in the name of Vinoo Mankad.
However, he wants the prize money to increase each year by 4%. How
much money should he invest today if BoI is willing to offer him 9% rate
of return?
Solution

Growing Perpetuity =

Amount to be invested = = Rs. 20,00,000

Time Value of Money – in Practice
P Gopichand wants to invest a certain sum in FD today that would
mature at his retirement, after 5 years. The rate offer is 7.35%. He
would invest the retirement proceeds in such a way that he should get
Rs. 50000 per year for next 10 years. The superannuation fund which is
willing to pay this return is claiming the rate of 9%. How much should
Mr. Gopichand invest?
 Time Value of Money – in Practice
Shahrukh plans to retire 16 years from now, on April 1, 2034. He wishes
to get a lifetime annuity of Rs. 250000 per year after retirement. The
fund manager has promised him 12% return on his investment, if
invested at the end of retirement period.
Shahrukh plans that he would deposit a fixed sum each year, for next
10 years, starting with April 1, 2018. This sum is invested at 11% p.a. at
the end of 10th year in a Fixed Deposit that would mature on the day of
retirement of Shah Rukh and provide for his lifetime annuity. The RD
return is 7.5%.
How much should he invest per year?
Thank You!