Time value of Money
Future value: (single payment or lumpsum investment)
1. If you invest 300 today for three years at 10 % interest compounded annually, what is
your investment worth after 3 years?
2. Ms Sita deposited 1000 rupees in her postal saving account which pays 10% interest
compounded i. annually ii. Semi-annually iii quarterly iv monthly., how much she
will get after four years.
3. Sheela invested 400 fours years ago in her account. her savings account is paying 4%
interest per annum. What will be the balance in her account if the interest rate is
compounded 1. Annually 2. Semi-annually,.
Future value: (ordinary annuity -end of the period)
4. Mr. Ram depositing every year 500 in his account to make down payment towards his
new house purchase. If the savings account interest rate is 8% what will be amount,
he accumulates in his account after four years?
a) If interest is compounded annually, semi-annually,
Future value ( Annuity due – beginning of the period)
5. Mr. Krishna invested 500 every year for four years at the beginning of the year he
deposited the amount every year. If his account is paying 8 % interest rate what will
be the amount accumulated at the end of four years?
a. If interest is compounded annually, semi-annually, quarterly Future value
(uneven cash flows)
6. Alice deposits rs 400, 300 and 250 rupees at the end of each of the next three years. If
the account earns 5% interest per annum what will be account balance at the end of 3
years.
Formulas:
𝑭𝑽𝒏 = 𝒑𝒗 (𝟏 + 𝒓)𝒏
(𝟏 + 𝒓)𝒏 − 𝟏
𝑭𝑽 (𝒐𝒓𝒅𝒊𝒏𝒂𝒓𝒚 𝒂𝒏𝒏𝒖𝒊𝒕𝒚) = 𝑷𝑴𝑻 ( )
𝒓
(𝟏+𝒓)𝒏 −𝟏
𝑭𝑽 (𝒂𝒏𝒏𝒖𝒊𝒕𝒚 𝒅𝒖𝒆) = 𝑷𝑴𝑻 [[ ] 𝒙 (𝟏 + 𝒓)]
𝒓
Semi annual; Quarterly ; monthly
𝑟
r=𝑚 t = t x m\
Present value
PV lumpsum
1. You expect to receive Rs 100000 after five years. If your required rate of return is
10% what is the amount you are required to deposit in your bank account today?
2. Assume a discount rate of 12% . calculate the present value of 10,000 received
after three years. If the interest rate is compounded annually, semi annually and
quarterly.
3. If Qasy can invest an opportunity cost rate equal to 12% compounded semi
annually what lumpsum amount should he invest today so that he is 2200000 to
buy a new car in three years.
PV ordinary annuity
4. Suppose your opportunity cost is 11% compounded annually how much must you
deposit in an account today if you want to pay yourself rs 230 at the end of each of
the next 15 years?
PV annuity due
5. How much must you deposit if you want to pay yourself 230 at the beginning of
each of the next 15 years?
6. Compute the amount amala must deposit in a account today so that she can pay
herself Rs 450 per month for the next nine years if her opportunity cost is 8%
compounded semi-annually. How much must amala deposit today if she wants to
pay herself at the beginning of each month? How much must amala deposit today
if she wants to pay herself at the end of each month?
PV uneven cash flows
7. Consider an investment gives you 1000, 1500, 800 1100 and 400 respectively at
the end of each of one through five years. How much would you like to invest at
the maximum today if your opportunity cost of capital is 8%?
Perpetuities
Most annuities call for payment to be made over some limited period of time, some annuities
go on indefinitely or perpetuities.
1
PVT= 𝑃𝑀𝑇 𝑟
Ex: invest in an investment that promises to pay 100 per year perpetuity. What is this
investment worth if the opportunity cost rate is 5% ?
What is r? ; what is n?
1. Ten years ago, Bhardwaj invested 1250 to day the investment is worth 3,550. If
interest rate is compounded annually what annual rate of return did Bhardwaj earn on
his investment?
Rule of 72
The rule says that to find the number of years required to double your money at a given
interest rate, you just divide the interest rate into 72. For example, if you want to know how
long it will take to double your money at eight percent interest, divide 8 into 72 and get 9
years.
1.
2.
3. How many years iit would take 1000 to double if it was invested in a back that pay
6% interest per annum?
Formulas:
𝐹𝑉
PV= (1+𝑟)𝑛
1
1−
(1+𝑟)𝑛
PV of ordinary annuity= 𝑃𝑀𝑇 [ ]
𝑟
1
1−
(1+𝑟)𝑛
PV of annuity due = 𝑃𝑀𝑇 [ ∗ (1 + 𝑟)]
𝑟
Sinking Fund
Sinking fund is a type of fund which is setup for repayment of debt or to meet the
future expenditure.
Ex: Shyam wants to buy a car worth 500000 after five years. To Buy that car Shaym
opened a separate account and regularly depositing amount to accumulate the money toward
his future purchase.
Problems:
1. ABC Ltd which has raised fund in the form of 1,000 zero coupon bonds worth
$1,000 each. The company wants to set up a sinking fund for repayment of the
bonds which will be after 10 years. Determine the amount of the periodic
contribution if the annualized rate of interest is 5% and the contribution will be
done i. yearly ii. half-yearly.
2. Company XYZ issued bonds worth of $5 million, having a 10% coupon rate and
maturing in 10 years. The company has set up sinking up to pay off the bond.
Coupons are to be paid semi-annually and the market interest rate says 6%.
3. Consider a food retail company A, which is doing well in its business and to
expand its business operations, they want to raise money through debt route. So
that is why they have issued $50,000 worth of bonds, which mature in 10 years
and has a sinking fund provision. Calculate the amount to be deposited regularly
in the Sinking Fund to repay this debt after 10 years.
4. Let us take an example of a sinking fund with a monthly periodic contribution of
$1,500. The fund will be required to retire a newly taken debt (zero coupon bonds)
raised for the ongoing expansion project. Do the calculation of the amount of the
sinking fund if the annualized rate of interest is 6% and the debt will be repaid in
5 years.
Sinking fund Formula (A)
(1+𝑟)𝑛 −1
1. Sinking fund (A) = ∗𝑃
𝑟
Frequency (semi annual / quarterly / monthly)
𝑟 𝑛∗𝑚
(1+𝑚) −1
Sinking fund (a) = 𝑟 ∗𝑃
𝑚
P = Periodic contribution to the sinking fund,
r = Annualized rate of interest,
n = No. of years
m = No. of payments per year
Periodic Contribution P
𝒓
𝒎
Periodic contribution P= 𝒓 𝒏∗𝒎
∗𝑨
(𝟏+ ) −𝟏
𝒎
P = Periodic contribution to the sinking fund,
r = Annualized rate of interest,
n = No. of years
m = No. of payments per year
Effective Interest rate
𝒓𝒔𝒊𝒎𝒑𝒍𝒆 𝒎
Effective annual rate r (EAR)= (𝟏 + ) −𝟏
𝒎
Example:
1. Yelanka bank advertises a savings investment that pays 6 percent compounded
monthly. What is the investment’s i. annual percentage rate (APR) ii. Effective
annual rate?
2. A bank offers an interest rate of 8% on deposits made with it. If the
compounding is done on a quarterly basis, what is the effective interest rate?
3.
Loan amortization
1. Suppose a firm borrows 100000 at an interest rate of 10% and the loan is
to be re-paid in 5 equal instalments payable at the end of each of the next 5
years. What is the annual instalment amount to be paid? And prepare the
loan schedules.
𝟏
𝟏−
(𝟏+𝒓)𝒏
PV of ordinary annuity = 𝑷𝑴𝑻 [ ]
𝒓
= PMT * (PV ordinary annuity factor for 15%, 5 years)
𝑃𝑉 (𝑙𝑜𝑎𝑛 𝑎𝑚𝑜𝑢𝑛𝑡)
PMT( loan instalment) = 𝑃𝑉 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑎𝑛𝑛𝑢𝑖𝑡𝑦 𝑓𝑎𝑐𝑡𝑜𝑟 𝑓𝑜𝑟 15% 𝑎𝑛𝑑 5 𝑦𝑒𝑎𝑟𝑠
2. Your father deposit 300000 on retirement in a bank which pays 10%
annual interest. How much can be withdrawn annually for a period of 10
years?
