Time Value of Money

Future Value of Single Amount

Future value is the value at a given future date of present amount placed on deposit today and earning interest at a specified rate. It depends on the rate of interest and the length of time. Concept of Compounding. FVn = PV (1+i)n  Jane placed Rs.40,000 in a fixed deposit account getting 8% interest compounded annually. She wants to know how much money she will get at the end of 6 years.

 Doubling Period Future Value of Multiple Flow. Suppose we invest Rs.1000 now (beginning of year 1, Rs.2000 at the beginning of year 2 and Rs.3000 at the beginning of year 3. How much these cash flow accumulate at the end of year 3. If the interest rate is 12% p.a.

Nominal Rate Vs. Effective Rate of Interest Compound Interest with non-annual Period: FV = PV (1+i/m)nm r = (1+i/m)m 1 [m = frequency of compounding]. Find out the effective rate of interest if the nominal rate of interest is 12% and compounded quarterly. Continuous Compounding. e.g. Calculate the compounded value of Rs.1000, interest rate being 12% p.a. and compounded continuously for 2 years.

 Under Pragati Cash Certificate Scheme of Syndicate Bank, a small odd sum can be invested for a period of 10 years. The certificates are issued in convenient denomination of Rs.1000, Rs.10,000 and Rs.1,00,000. The rate of interest is 12% p.a. compounded quarterly.
What is the issue price of a certificate of Rs.1,00,000?

Annuity

Sinking Fund: An Application

It is a fund which is created out of fixed payments in each period to accumulate a future sum after a specific period. Mr. Rajiv plans to send his son for studying MBA after 10 years. He expects the cost of study would be 15 lakhs. How much should he saved annually if he gets an interest rate of 10%.

Present Value of Single Amount

Present value is the current Rupee value of a future amount. The amount of money that would have to be invested today at a given interest rate over a specific period to equal the future amount. Concept of Discount. PV = FV/ (1+i)n Mr. Sam wish to find the present value of Rs.1,70,000 to be received 8 years from now, assuming an 8% opportunity cost.

Present Value of Multiple Flow

Year 1 2 3 4 5 6 7 8 9 10 Option 1 100 200 300 400 500 600 700 800 900 1000 5500 PV 2591 Option 2 500 500 500 500 500 500 500 500 500 500 5000 2825 Option 3 1000 900 800 700 600 500 400 300 200 100 5500 3625 If the discount rate is 12% compare the different alternatives.

Present Value of Annuity

An annuity is a level of regular payments that lasts for a fixed number of periods. You own a Lottery, which pays Rs.1,00,000 a year for 20 years. You will receive your first payment a year form now. If the interest rate is 7%, what is the true value of the lottery?

A Delayed Annuity
This is an annuity begins at a date in the future. Sunita will receive a four years annuity of Rs.25,000 per year as a part of her scholarship beginning at the 6th year. If the interest rate is 8%, what is the present value of her annuity?

Ordinary Annuity Vs. Annuity Due

In general, we assume that the series of cash flows occur at the end of the period. This is an example of ordinary annuity. In practice, (e.g. lease, hire purchase) usually the cash flows take place in the beginning of the period, subsequent installments also in the beginning of the period. Annuity due is a series of fixed receipts/payments starting at the beginning of each period for a specific number of period.

Annuity Due
In the previous Lottery Example you receive Rs.1,00,000 a year for 20 years where you receive the first payment a year from the winning date. If the first payment occurs immediately recalculate the value of the lottery.

The Infrequent Annuity

In this case the annuity payment occurring less frequently than once a year. Raju will receive an annuity of Rs.20,000 payable once in every two years. The annuity stretches over 20 years. The first payment occurs after 2 years from now. The annual interest rate is 7% p.a. Calculate the present value of the annuity.

Capital Recovery
Capital Recovery is the annuity of an investment for a specific time at a given rate of interest. The reciprocal of the present value annuity factor is called the capital recovery factor. Suppose you have taken a bank loan of Rs.3,00,000 for 5 years to buy a car. You have to pay interest of 12% p.a. What would be the annual installment you need to pay?

Loan Amortization
Loan to buy a flat = Rs. 22 lakh Floating rate = 9% - 11% Repayment period = 20 years Payment interval = Monthly

Construct a loan amortization schedule.

Equating Present Value of Two Annuities Mr, Rajkumar is Planning for his new born son s engineering education. He has estimated the college expenses will be Rs.4,00,000 a year when his son will reaches college in 18 years. The annual interest rate over the next two decade will be 9%. How much money Rajiv must deposit in the bank each year so that his son will get full financial support through out 4 years of college?

Growing Annuity
It is a finite number of growing cash flows. In our previous example Mr. Rajkumar planned to increase his payments at 3% per year. What would be his first payment?

Present Value of Perpetuity.

Perpetuity is an annuity that occurs indefinitely. An investors expects a perpetual sum of Rs.500 annually for his investment. What is the present value of the perpetuity if the rate of interest is 10%.

 Annual Percentage Rate (APR): It is the nominal annual rate found by multiplying the periodic rate by number of period in one year. Annual Percentage Yield (APY): It is the effective annual rate a saving product pays.