The Time Value of Money

Money NOW
is worth more than
money LATER???

 You have won a cash prize! You have two payment

options:

A. Receive Rs 10,000 now

OR

B. Receive Rs 10,000 in three years

Which option would you choose?

 Money available at the present time is

worth more than the same amount in the
future due to its potential earning capacity.
Receiving Rs 10,000 today, you are
balanced to increase the future value of
your money by investing and gaining
interest over a period of time.

Time Value of Money

The value of Unit of money is different in
different time periods.

Also know as Time Preference for money.

IMPORTANCE
CAPITAL BUDGETING
Cost of Project: Rs 10,00,000. (Cash
Outflow)
Period =1 year
Profit = 80,000
One year later the total amount:
10,80,000 (cash inflow)
Whether to accept the project?

Consider another alternative

Rs 10,00,000 suppose invested in bank
@ 10% interest
Then the cash inflow after 1 year is Rs
11,00,000
Earlier decision will have to be revised.

 On the other hand when decision is made

to raise a loan of Rs 10,00,000 from
financial institution.
First identify the cash inflow (Future)
????????
To decide upon the commitments (Interest
and Amount payment)

Decision based on cash flow?

Meaningful comparison cash flow that results

in different time periods it is necessary to
convert the sum of amount in common point.

To simplify understand that

there are only a few basic
types of techniques for
calculating Time Value Of
Money.

A sum of money today is

called a present value.
We designate it mathematically as
occurring in time period 0
Example: P0 = 1,000 refers to Rs1,000
today

A sum of money at a future

time is termed a future value
We designate it mathematically as
occurring in time period n.
For example: Sn = 5,000 refers to Rs
5,000 after n periods from now.

The number of time periods in

a time value problem is
designated by n.
n may be number of years, months
n may be a number of any defined time
periods

The interest rate or growth

rate in a time value problem is
designated by i
I expressed as interest rate per period.
For example if n is a number of years, i
must be the interest rate per year.
If n is a number of months, i must be the
interest rate per month.

The first of the general type of time

value identifications is done through

i. Compounding
ii Discounting

 Compounding identifies :Future value

and
Discounting identifies : Present value

 To calculate the Future value of cash

flows:
Sn = P0(1+i)n

An example problem: Future vale

If you invest Rs 1,000 today at an interest
rate of 10 percent, how much will it grow
to be after 5 years?

Sn = P0(1+i)n

Sn = 1,000(1.10)5

Sn = Rs 1,610.51

 Tedious job, calculating future value for 20

years or more.
Difficult to calculate.
(1+i)n value is easily calculated by
Compound sum of Re1 Table value

Using Compound sum of Re1

Table value
Deposit Rs 1000 today in a bank pays 10
percent interest compounded annually.
How much will the deposit grow to after 8
years.
The value of FVIF for 10% 8 years shows
2.144
Therefore future value= 1000*2.144
= 2,144

Important Observations
Interest rate increases for a given year,
the compounding interest factor also
increases.
Higher the interest rate higher the future
cash flow.

 For the given Interest rate the future sum

of money increases with the passage of
time.
Longer the period of time higher the
Interest Factor.
Zero= 1

 Seen Future value calculation for single

payment done @ present.
Compounded value of a series of
Payment
?????????

Time value problems involve is

Annuities
An annuity is an amount of money that
occurs (received or paid) in equal
amounts at equal time intervals.
Stream of equal annual cash flows.

For example:
If you make payments of Rs 2,000 per
year into a retirement fund, it is an annuity.
If you receive pension checks of Rs 1,500
per month, it is an annuity.
If an investment provides you with a return
of Rs 20,000 per year, it is an annuity.

Future value - Annuity

X deposits Rs 2,000 at end of every year
for 5 years in his savings account paying
5% interest compounded annually.
Determine the sum of amt he will receive
at the end of 5th year.

Compound Interest factor for

Annuity Table
Sn= A * CVIFA (Comp. interest factor for
future annuity) (5% & 5 years)
Sn= 2000 * 5.526= 11,052

Present Value / Discounting

Current value of Future amount.

Amount invested today @ a given interest

rate over a specified time period to equal
the future amount.
Discounting is the present value of future
amount.

Present Value of Annuity

Example
ABC co. expected to receive Rs1,00,000
of 10 years from a new project just taken.
How much will be the present value of
Annuity? Assume 10% interest.
Po= A *(Annuity Discount Factor)
= 1,00,000* (10% 10 years ADF)
= 1,00,000*6.145
= 6,14,500