Chapter 3
TIME VALUE OF MONEY
LEARNING OUTCOMES
After going through the chapter student shall be able to understand
❑ Meaning of Time Value of Money
❑ Calculation of Future value (Compounding)
❑ Calculation of Present value (Discounting)
❑ Annuity and PV of Annuity
❑ Concept of Interpolation and Calculation of Compound Interest Rate
❑ Perpetuity and PV of Constant perpetuity and Growing perpetuity
❑ Effective Interest Rate.
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3.2 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
PV OF AN ANNUITY
Question No. 1A
Y bought a TV costing 13,000 by making a down payment of 3000 and agreeing to make equal annual payment
for 4 year How much would be each payment if the interest on unpaid amount be 14% p. a. compounded annually?
Ans: 3,432
Question No. 1B
Ms. Priyanka chopra plans to receive an annuity (Sequence of periodic payment) of 50,000 semi annually for 3
years after she retires from bolly wood in 2 years from now. Money is worth 9% p.a. compounded semi annually.
What amount of single deposit made now would provide the funds for the annuity.
Ans: 216,250
TEST YOUR KNOWLEDGE
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Question No. 1.1
Mr. Pravin requires a monthly payment of 1000 for 5 years from a mutual fund that has a track record of paying
9% per annum. What should be his investment today to get this amount?
[CMA-MTP-Dec-2014-New-2M]
Ans: 48173.37
Question No. 1.2
Suppose 5,000 is paid every year for 10 years to pay off a loan. What is the loan amount if interest rate be 14%
per annum compounded annually?
Ans: 26,080
FV OF AN ANNUITY
Question No. 2A
How much amount is required to be invested every year so as to accumulate 3,00,000 at the end of 5 years if
interest is compounded annually at 10%?
Ans: Amount to be invested every year = 49,140
TEST YOUR KNOWLEDGE
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Question No. 2.1
A machine costs a company 26,00,000 and its effective life is estimated to be 10 years. A sinking fund is created
for replacing the machine by a new model at the end of its life time, when its scrap realizes a sum of 2,50,000
only. The price of the new model is estimated to be 25% higher than the price of the present one. Find what amount
should be set aside each year, out of the profits for the sinking fund, if it accumulates at 10% p.a. compounded
annually.
Ans: Amount to be set aside = 1,88,241
CALCULATION OF FUTURE VALUE / PRESENT VALUE
Question No. 3A
A person opened an account on 1 April, 2009 with a deposit of 80,000. The account paid 6% p. a. interest
compounded quarterly. On 1st October 2009, he closed the account and added enough additional money to invest
in a 1 year time deposit earning 8% p.a. compounded half yearly, so that this money will become 3,00,000 on 1st
October 2010.
How much additional amount did the person invest on 1st October 2009?
Ans: Additional amount to be invested = 1,94,949
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FOREIGN EXCHANGE EXPOSURE AND RISK MANAGE 3.3
Question No. 3B [Nov-1998-5M]
P Co. has to make payment of 2 million ( 20 lakhs) on 16th April, 1998. It has a surplus money today i.e. 15th
January, 1998 and the company has decided to invest in Certificate of Deposit (CD’s) of a leading nationalized bank
at 8.00% p.a. What money is required to be invested now? Take year as 365 days.
Ans: Amount to be invested = 19,60,890
Question No. 3C
Mr X invests 2000 at end of first year and similar amount at end of second and third year in an account.
Current year interest rate is 10% which is going to increase by 1% (Absolute value) every year. Calculate
future value which will accumulate at end of third year in his account.
TEST YOUR KNOWLEDGE
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Question No. 3.1
If 5000 is invested at annual rate of 9% p. a. compounded continuously, find the amount at the end of 6 years.
[Given: e0.54 = 1.71601]
Ans: Amount at 6 year end = 8580.05
Question No. 3.2
Mr. X wish to get her daughter admitted into a medical college after 15 years from now. He will be required total
25,00,000 to get admission into the college. For this he has identified a fund, which pays interest @ 9% p.a. In
this regard he wanted to know the amount to be invested in each of the following situations:
(a) If he decides to make annual payment into the fund at the end of each year;
(b) If he decides to invest a lump sum in the fund as on today
(c) If he decides to make annual payment into the fund at the beginning of each year.
(FVIF/ CVF (15, 0.09) = 3.642, FVIFA/ CVFA (15, 0.09) = 29.361, PVIF/ PVF(15, 0.09) = 0.275 and PVIFA/
PVFA (15, 0.09) = 8.061).
Ans: (a) 85,146.96 p.a; (b) 6,86,436.02; (c) 78,117.68 p.a.
RETURN ON INVESTMENT / COST OF BORROWING
Question No. 4A
Mr. A has invested 10,000 on 1 Jan, 2014. He will receive 6000 at end of 1st year and 6000 at end of 2 nd
year. Calculate Semi Annual compounded return which Mr. A will earn form that investment.
TEST YOUR KNOWLEDGE
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Question No. 4.1
Mr. ABC borrowed 10,000 for 2 year from a Bank. Installment of 7000 is payable at end of each year for 2
years. Bank charges Interest on Semi Annual compounding basis. Calculate borrowing rate quoted by Bank.
Question No. 4.2
Mr. X has to pay 15,000 premiums per annum for a LIC Plan till 10 years. Premium is payable at beginning
of each year. He will get 450,000 at end of 10 years. Calculate annual rate of return he will earn from that
plan.
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3.4 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
PV OF CONSTANT PERPETUITY AND GROWING PERPETUITY
Question No. 5A
Calculate the amount of investment to be made today for an annuity plan offered by Life insurance plan under which
20,000 receivable annually for life time of the investor. Interest rate is 10 % pa. compounded annually.
Question No. 5B
Calculate the amount of investment to be made today for an investment plan under which he want to receive 5000
at end of first year and from second year onward amount with 5% annual growth for life time. Interest rate is 12.5
% pa. Compounded annually.
EFFECTIVE INTEREST RATE
Question No. 6A
If the interest is 10% p.a. payable quarterly, find the effective rate of interest.
TEST YOUR KNOWLEDGE
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Question No. 6.1
Bank of Delhi pays 8% interest, compounded quarterly, on its money market account. The managers of Bank of
Gurgaon want its money market account to equal Bank of Delhi’s effective annual rate, but interest is to be
compounded on monthly basis. What nominal or quoted rate must Bank of Gurgaon Set?
Question No. 6.2
Calculate the maturity value of a recurring deposit of 500 p.m. for 12 months @9% P. a. compounded
quarterly.
// CA NAGENDRA SAH // WWW.NAGENDRASAH.COM
