TIME VALUE OF MONEY

Summary of Compounding and Discounting Formulas

S.No. Purpose Given Calculate Formula
1. Compound (Future Present Value(P) Future F=P(1+i)n
Value) Value of Value(F)
Lumpsum
2. Compound (Future Annuity (A) Future F=A[{(1+i)n -1}/i]
Value) Value of an Value(F)
Annuity
3. Sinking Fund Future Value(F) Annuity(A) A=F[i/{(1+i)n – 1}]
4. Present Value of Future Value(F) Present P=F[1/(1+i)n ]
Lumpsum Value(P)
5. Present value of Annuity(A) Present P=A[{1/i}-{1/i(1+i)n }]
Annuity Value(P)

6. Multiple compound Present Value(P) Future FV=PV(1+r/m)mn

Periods per year Value(F) m=no. of compounding periods per yea
n= total no. of years.
7. Capital Recovery or Annuity Present Value A=P[{i(1+i)n}/{(1+i)n-1}]
Loan Amortization
8. Present Value of Annuity(A) Present Value P=A/i
Perpetuity P
9. Present Value of Annuity(A) Present P=A/(i-g)
Constantly Growing Value(P)
Perpetuity
10. Compound Value of Annuity(A) Future F=A[{(1+i)n-1}/i](1+i)
an Annuity Due Value(F)
11. Present Value of an Annuity(A) Present P=A[{(1+i)n -1}/{i(1+i)n}](1+i)
Annuity Due Value(P)

TWO ALTERNATIVES PROCEDURE CAN BE USED TO FIND THE VALUE OF

CASH FLOWS
1. COMPOUNDING: Future Value
2. DISCOUNTING: Present Value
Compounding is the process of finding the future values of cash flow by applying by
applying the concept of compound interest. Simple Interest is the interest that is calculated
only on the original amount Principle.
Two types of cash flows: 1. Lumpsum or single payment which is deposited at a time.
2. Annuity: It is a fixed payment or receipt each year for a specified no. of years. E.g equal
instalments loan from the house financing companies.
1.Future Value of single cash Flow (Lumpsum): In compounding, future values of cash
flow at given interest rate at the end of given period of time are found (Future values of single
cash flow)
Compounding is the process of finding the future values of cash flow by applying by
applying the concept of compound interest. Simple Interest is the interest that is calculated
only on the original amount Principle.
Formula No.1 & 4 in above Table: (FV OR PV of single lumpsum cash)
Future Value (Compounding) of Present money (lumpsum)
FV=PV(1+i)n
Present Value (Discounting) of Future money (Lumpsum)= F[1/(1+i)n ]
e.g: Suppose Rs. 1000 are placed in the saving A/c at 5% interest Rate. How much shall it
Grow at the end of 3 yrs.
FV=PV(1+i)n = 1000(1+.05)^3=1157.6
2. Future Value of Annuity: If you rent a flat and promise to make a series of payments
over an agreed period. The future value of payment series over an agreed period.
F=A[{(1+i)n -1}/i]
e.g: Suppose a firm deposits Rs. 100 at the end of each of the next year 3 years at 10% rate of
interest. How much would this annuity accumulate at the end of 3 year?
F= 100[(1.10)^3 -1]/.10 = Rs.331
3. Sinking Fund: Sinking Fund is a fund, which is created out of fixed payments each period
to accumulate to future sum after a specified period. In above example suppose we want to
accumulate Rs.331 at the end of 3 years from now. How much should we deposit at the
interest rate of of 10% so that it grows to Rs.331.(Sinking fund is reciprocal of Future Value
of Annuity)
A=F[i/{(1+i)n – 1}]
4. Present Value of single cash Flow (Lumpsum): Reciprocal of Future Value of single
cash flow (lumpsum):
Present value of Future Cash Flow(inflow or outflow) is the amount of current cash that is of
equivalent value in to the decision maker.
Discounting is the processes of determining present values of a series of Future cash Flows.
P=F[1/(1+i)n ]
e.g: An investor wants to find out the present value of Rs.200000 to be received after 15
years. The interest rate is 9 %.
5. Present Value of Annuity: An Investor may have opportunity of receiving an annuity- A
constant periodic amount for a certain specified number of years.
P=A[{1/i}-{1/i(1+i)n }]
e.g: Suppose that person receives an annuity of Rs. 5000 for 4 years. If the rate of Interest
rate is 10% the present value of Rs.5000 annuity is:
P=5000[{1/0.1}-{1/0.10(1.10)^4}]
6. Loan Amortisation and Capital Recovery:
Capital Recovery is the annuity of an investment made today, for a specified period of time,
at a given rate of Interest.
A=P[{i(1+i)n}/{(1+i)n-1}]
Eg: Suppose you plan to invest Rs.10000 today for a period of 4 years. If your interest rate is
10% , How much Income per year should you receive to recover your investment?
7. Present Value of Perpetuity: Perpetuity is an annuity that occurs indefinitely.
Present value of Perpetuity: Perpetuity(A) /Interest Rate(i)
Eg: Let us assume that an investor expects a perpetual sum of Rs. 500 annually from his
investment. what is the present value of this perpetuity if interest rate is 10%?
Ans. 5,000
8. Present Value of Growing Perpetuity: Constantly growing perpetuities are annuities
growing indefinitely. Suppose dividends of Rs.66after 1 year are expected to grow at 10%
indefinitely. The discount rate is 21%. Hence the present value of dividend as follows:
P=A/(i-g) = 66/.21-.10= 600
9. VALUE OF ANNUITY DUE:
The concept of compound (Future) Value and present value of an annuity discussed earlier
are based on the assumption that series of cash flows occur at the end of the period. In
practice cash flows could take place at the beginning of the period. When you buy the fridge
on an instalment basis, the dealer requires to make the first payment immediately and
subsequent instalments in the beginning of each period.
A) Future value of an Annuity due: Annuity due is a series of fixed receipt or payments
starting at the beginning of each period for a specified number of periods. Eg: suppose you
deposit Rs.1 in a saving accounts at the beginning of each year for 4 years to earn 6%
interest? How much will be the compound value at the end of 4 years?
F=A[{(1+i)n-1}/i](1+i)= Rs.4.637.
B) Present Value of an Annuity due: let us consider a 4 years annuity of Rs. 1 each year,
interest rate is 10%. What is the present value of this annuity if each payment is made at the
beginning of each year?
P=A[{(1+i)n -1}/{i(1+i)n}](1+i)= Rs.3.487

Que1: Suppose Rs. 1000 are placed in the saving Accounts of Bank at 5% interest Rate. How
much shall it Grow at the end of 3 years?
Q-2 A firm deposits Rs. 5000 at the end of each year for 4 years at 6% of interest. How much
would this annuity accumulate at the end of the fourth year?
Q-3 Suppose we want to accumulate Rs. 21,875 at the end of 4 years from now. How much
should we deposit each year at an interest rate of 6% so that it grows to Rs. 21,875 at the end
of fourth year?
Q-4 An investors wants to find out the present value of Rs. 50,000 to be received after 15
years at 9% interest rate?
Q-5 An investors expects a perpetual sum of Rs. 500 annually from his investment. What is
the present value of this perpetuity if interest rate is 10%?
Q-6 XYZ Bank pays 12% and compound interest quarterly. If Rs. 1000 is deposited initially,
how much shall it grow at the end of 5 Years?
Q-7 Sadhulal Bhaib is borrowing Rs. 50,000 to buy a low-income group house. If he pays
equal instalments for 25 years at 4% interest on outstanding balance. What is the amount of
instalment? What shall be amount of instalment if quarterly payments are required to be
made? Ans: Approx. Rs.3201 Quarterly payment: Rs793
Q-8 Suppose you have borrowed a 3year loan of Rs. 10,000 at 9% from your employer to buy
a motorcycle. If your employer requires three equal end of years repayment, then what will
be the annual Instalment. Ans: 3,951