Professional Documents
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MONE Y
MAN AGEMENT FIN AN CE
TIME VALUE OF MONEY
An investment of one
rupee today would grow
to (1+r) after a year.
Hence ‘r’ is the rate of
return earned on the
investment
In an inflatory period, a
rupee today represents a
greater purchasing power
than a rupee a year hence
FUTURE VALUE OF A SINGLE
AMOUNT
FUTURE VALUE OF AN ANNUITY
PRESENT VALUE OF A SINGLE
AMOUNT
PRESENT VALUE OF AN ANNUITY
Suppose you have invested
Rs 1000 today and deposited
with financial institution which
pays 10% interest compounded
annually for a period of 3 years
Rs 1000 today and deposited with financial institution which pays 10%interest
compounded annually for a period of 3 years.
FIRST YEAR
Principal at the beginning 1000
Interest for the year (1000x0.10) 100
Principle at the end 1100
SECOND YEAR
Principal at the beginning 1100
Interest for the year (1000x0.10) 110
Principle at the end 1210
THIRD YEAR
Principal at the beginning 1210
Interest for the year (1000x0.10) 121
Principle at the end 1331
FORMULA
The process of investing money as well as reinvesting the
interest earned thereon is called compounding.
The future value or compounded value of an investment after n
years when the interest rate is r percent is
FVn = PV (1+r)n
Where
FVn = future value n years hence
PV = Cash today (present value)
r = number of years for which
compounding is done
Value of FVIFr,n for various
combinations of ‘r’ and ‘n’
FVIF TABLE
Alternatively you can consult a
future value interest factor table
Suppose you deposit Rs 1000/- today
in a bank that pays 10% interest
compounded annually. How much
the deposit grow after 8 years and
12 years
After 8 years Rs 1000(1.10)8 = Rs 1000(2.144) =Rs 2144/-
COMPOUND AND SIMPLE
INTEREST
In compound interest each payment is
reinvested to earn further interest for
future period
In simple interest, no interest is earned on
interest
Exam pl e f or sim ple inter est
FUTURE VALE = PV[1+no of yrs x int.rate]
Rs 1000 invested at 10%for simple interest
for 100 yrs
1000x[1+100x .10] = 1000 x[ 1+10] = Rs
11, 000/ -
Exam pl e f or compound inter est
SEE THE DIFFERENCE !!!
Rs 1,37,80,612
or
Rs 137.8 lakhs
Or
DOUBLING PERIOD
(1+g)10 =1000/100 = 10
1+g = 101/10
g = 101/10 – 1
=1.26-1=0.26 = 26%
PRESENT VALUE OF A SINGLE
AMOUNT
Suppose some one promise Rs 1000/-
a year hence. The value will be
definitely less than 1000
we already know the formula for
future value - FVn = PV (1+r)n.
Dividing both sides by (1+r)n we get
PV = FVn[ 1/ (1+r)n]
The factor [1/ (1+r)n] is called the
present value index factor for
different combinations of r and n.
Table for PVIF for different r,n
[ 1/ (1+r)n]
PROBLEM-PRESENT VALUE
1100
1210
1331
1464
--------------
6105
----------------
Value of FVIFArn for various
combinations of r and n
FORMULA
APPLICATIONS
Knowing what lies in store for you
= 30000x199.03
= Rs 59,70,600
How much should you save
annually
You want to buy a house after 5
years when it is expected to cost
Rs 2m. How much should you save
annually if your savings earn a
compound rate of 12%
FVIFA (n=5, r=12%)= (1+0.12)5-1
0.12
= Rs 2000000
6.53
Annual deposit in a sinking
fund
Abc ltd has an obligation to redeem
Rs 5000m bonds 6 years hence. How
much the company deposit annually
in the fund account where in it earns
14% interest to accumulate Rs 500m
in 6years time.
FVIFA n=6,r=14 = (1+r)n-1 = (1+0.14)6-1
r 0.14
= 8.536
THE ANNUAL SINKING FUND DEPOSIT
Finding interest rate
2nd STEP
Look at FVIFAr,n table and read the row corresponding
to 6 years until you find close to 8.00
FVIFA 12% ,6 IS 8.115
SO CONCLUDE THE RATE OF INTEREST -12%
HOW LONG SHOULD U WAIT
You want to take a trip abroad
which costs Rs 1000000/-
You can save annually Rs 50000/-to
full fill the desire. How long will
have to wait if your savings earn
an interest of 12%
You want to take a trip abroad which costs Rs 1000000/-
You can save annually Rs 50000/-to full fill the desire. How long will
have to wait if your savings earn an interest of 12%
The future value of an annuity of Rs 50000/- that earns 12% is
equal to Rs 1000000/-
50000xFVIFA n=?,12% = 1000000
=50000 x(1+r)n-1 = 1000000
r
=50000 x1.12n-1 = 1000000
0.12
=1.12n-1 = 1000000 X 0.12 = 2.4
500000
0 1 2 3
901.1
826.4
751.3
2478.8 =present value
Formula
In general terms, the present value of
an annuity may be expressed as
follows
PVAn = A + A + ----A + A
1+r (1+r)2 (1+r)n-1 (1+r)n
A 1 + 1 + ----1 + 1
1+r (1+r)2 (1+r)n-1 (1+r)n
A 1 1
(1+r)n
formula
A 1 1
(1+r)n
r
A perpetuity is an annuity of
infinite duration
Formula is
P<> = A X PVIF r, <>
Where P<> = present value of a
perpetuity
A = constant annual payment
PVIFA r <> = present value interest
factor for a perpetuity –
Present value of a perpetuity