TIME VALUE OF MONEY

TIME VALUE OF
MONEY.
Main objective of Financial Management is to maximize shareholders wealth.

Three important functions of finance manager:-

FINANCING

INVESTING

DIVIDEND

Reason behind the concept of “Time Value Of Money” is ‘Interest’.

UNIQUE QUESTION
Question :

If we invest today ₹ 100. How much we receive at the rate of interest at 10%p.a.
compounded annually at T1 , T2, T3, T4, T5 ?

Answer :

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 TIME VALUE OF MONEY

r = 10%

Whereas,

T0 = Today’s value / Present value

T1 = End of the first year

T2 = End of the second year

T3 = End of the third year

T4 = End of the fourth year

T5 = End of the fifth year

r = 10%

PV = 100 × 10% =10

100 + 10 =110

PV = 110 × 10% = 11

110 + 11 =121

PV = 121 × 10% = 12.1

121 + 12.1 =133.1

PV = 133.1 × 10% =13.31

133.1 + 13.31 =146.41

PV = 146.41 × 10% = 14.64

146.41 + 14.64 =161.05

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 TIME VALUE OF MONEY

Meaning,

If we invest ₹ 100 today (T0) at the end of fifth year we receive ₹ 161.051

At the end of fifth year ₹ 161.05 Principal and Interest both are included.

Future value = Present value (1+r)n

∴ = 100 (1+0.10)5

∴ = 100 (1.0105)

∴ Future value = 161.051

Where as,

F.V = future value

P.V = present value

r = rate of interest for the period

n = number of compounding/periods

 To go from present to future is known as Compounding.

.
 To go from future to present is known as Discounting.

Interest for 5th year = Value at T5 – Value at T0

= 161.05 – 100

I.e. , Interest for 5th year = 61.05

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 TIME VALUE OF MONEY

 When we talk about factor, we always think from ₹.1 point

of view.
 Factor’s include Interest as well as Principal.

VERY IMPORTANT

 Fraction and factors

For eg. (fractions)

(1) 10% = 10 per cent (cent=centuries)

∴ = 10 per 100

10
i.e. = 0.10
100

i.e. 0.10 is a fraction.

(2) 15% = 15 per cent

= 15 per 100

15
i.e. = 0.15
100

i.e. 0.15 is a fraction.

(3) 17% = 17 per cent

= 17 per 100

17
i.e = 0.17
100

i.e 0.17 is a fraction.

(4) 2.5% = 2.5 per cent

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 TIME VALUE OF MONEY

= 2.5 per 100

2.5
i.e. = 0.025
100

i.e. 0.025 is a fraction.

EXAMPLE

QUESTION ~ Calculate the fractions.

(1) 22.5% ->

(2) 19.6% ->

(3) 100% ->

(4) 20% ->

(5) 3% ->

(6) 19% ->

(7) 25% ->

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 TIME VALUE OF MONEY

(8) 16% ->

(9) 200% ->

(10) 150% ->

For eg. (Factors)

(1) 10% = 10 per cent
= 10 per 100
10
i.e. = 0.10 + 1
100
i.e. 1.10 (factor of 10%).

(2) 15% = 15 per cent

= 15 per 100

i.e. = 0.15+1

i.e. 1.15 (factor of 15%).

 Factors always refers on ₹ 1.

Meaning,

If we invest ₹ 1 today at the end of first year we receive 1.10

EXAMPLE :

Question:

Calculate 10% of at the end of the fifth year.

Answer:
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 TIME VALUE OF MONEY

10%

10 per cent

10 per 100

10
= 0.10+1
100

= (1.10)5

Meaning,

If we invest ₹1 today at the end of the fifth year we receive (1.10)5

EXAMPLES

Calculate the factors

(1)28.5% ->

(2)15% ->

(3)19.9% ->

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 TIME VALUE OF MONEY

(4)100% at the end of 10th year

(5)17.7% ->

UNIQUE QUESTION

Question :

Calculate future value and Interest amount at the end of 5th year compounded
annually. If present value is ₹ 5,00,000 & Rate of interest is 7%

Answer:

F.V = P.V (1+r)n

= 5,00,000 (1+0.07)5

= 5,00,000 (1.07)5

= 5,00,000 × 1.40255

F.V. = 701275.86

Interest = Future Value – Present Value

∴ = 701275.86 – 5,00,000

Interest = 201275.86

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 TIME VALUE OF MONEY

Now, with the help of above question find present value if future value is
701275.8

F.V. = P.V (1+r)n

F.V.
P.V. =
(1+r)n

701275.86
= P.V.
( 1+0.07)5

701275.86
= P.V.
(1.40255)

5,00,000 = P.V

.Formula.

F.V. 1
P.V. = OR P.V. = F.V. ×
(1+r)n ( 1+r )n

Where as ,

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 TIME VALUE OF MONEY

(1+r)n = factor

Or

1
- Discount factor/ Present value
( 1+r )n
factor/ Present value interest factor

(1) P.V (1+r)n = F.V.

(2) Interest = Future Value – Present Value

UNIQUE POINTS
 To convert Present value into future value multiply with compound value factor/
compound value interest factor/ future value factor.

 To convert future value into present value divide by (1+r)n or multiply by

1
Or Discount factor/ Present value factor/ Present value interest
( 1+r )n
factor.

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 TIME VALUE OF MONEY

Interest Rate

Compensation for Inflation Premium Risk

defement of
consumption

 Compounded annually
 Compounded semi-annually
 Compounded quarterly
 Compounded monthly

For e.g.

Interest Rate 12% p.a.

Compounded annually

 Divide 12% by 1
 In other words there is no number in this world which can divide 12%

Compounded semi-annually

 To be compounded every 6 month

e.g. If r = 12% p.a

r 12%
then, = = 6% ( Rate of Interest for 6 months)
2 2

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 TIME VALUE OF MONEY

6
factor of 6% is
100
+ 1= 1.06

Meaning
If we invest ₹1 today than we will receive 1.06 at the end of
6 months.

Logic ,

12M 12%
6M X

6×12%
x =
12

 x = 6%

Common sense

r = 12% p.a. (C.S.A.)

6M factor = (1.12)1
12M factor = (1.12)2
18M factor = (1.12)3
24M factor = (1.12)4

Compounded quarterly
 To be compounded every 3 months

e.g. If r = 12% p.a.

12%
r= = 3% (Rate of interest for 3 months)
4

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 TIME VALUE OF MONEY

3
factor of 3% is + 1 = 1.03
100

Meaning

If we invest ₹ 1 today than we will receive 1.03 at the end of 3 months

Logic

12M 3M
3M X

3×12
x=
12

x = 3%

Common sense

r = 12% p.a. (C.Q)

3M factor = (1.12)1
6M factor = (1.12)2
9M factor = (1.12)3
12M factor = (1.12)4

Compounded Monthly
 To be compounded every month
e.g.
If r = 12% p.a.
12%
r= = 1% (Rate of Interest for 1 month)
12
1
Factors of 1% = + 1 = 1.01
100

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 TIME VALUE OF MONEY

Meaning

If we invest Rs.1 today than we will receive 1.01 at the end of 1 month logic,

logic

12M 12%
1M X

1×12%
x =
12

∴ x = 1%

Common Sense

r = 12% p.a. (C.M.)

1M factor = (1.12)1
6M factor = (1.12)6
9M factor = (1.12)9
12M factor = (1.12)12

UNIQUE QUESTION

Question :

₹ 10,000 invested today, how much we receive at the end of fifth year If
r = 12% p.a..

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 TIME VALUE OF MONEY

 Compounded annually?
 Compounded semi-annually?
 Compounded quarterly?
 Compounded monthly?

Answer :

 Compounded Annually

f.v = P.V. (1+r)n

= 10,000 (1+ 0.12)5

= 10,000 (1.12)5

= 10,000 × 1.7623

f.v = 17623.41

 Compounded semi-annually

12%
r= = 6% at the every 6 months
2

n = 5 years = 5×2 = 10 times compounding

Meaning

If we invest ₹ 1 today than we will receive (1.06) at the of 6 months

F.V. = P.V. (1+r)n

= 10,000 (1+0.06)10

= 10,000(1.06)10

= 10,000 × 1.7908
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 TIME VALUE OF MONEY

F.V. = 17908.47

 Compounded quarterly

12%
r= = 3% at the every 3 months
4

n = 5years × 4 = 20 times compounding.

Meaning

If we invest ₹ 1 today than we will receive (1.03) at the end of 3 months

F.V. = P.V. (1+r)n

= 10,000 (1+0.03)20

= 10,000 (1.03)20

= 10,000 × 1.8061.11

F.V. = 18061.11

 Compounded monthly
12%
r= = 1 at the end of 1 month,
12

n = 5 years×12= 60 times compounding

Meaning

If we invest ₹.1 today than we will receive (1.01) at the end of 1 month

F.V. = P.V. (1+r)n

= 10,000 (1+0.01)60

PROF. ASHISH PARIKH UNIQUE ACADEMY 8007916633/22

 TIME VALUE OF MONEY

= 10,000 (1.01)60

= 10,000×1.8166

F.V. = 18166.96

ANSWERS

 Compounded annually (12%) = ₹ 17623.4

 Compounded semi-annually (12%) = ₹ 17908.47
 Compounded quarterly (12%) = ₹ 18061.11
 Compounded monthly (12%) = ₹ 18166.96

Here,

If rate of interest is similar than more compounding more benefit

For eg: calculate (1.04)7/12

STEP 1 -> Press √ 12 times

STEP 2 -> - 1 =
STEP 3 -> × 7 ÷ 12
STEP 4 -> + 1 =
STEP 5 -> Press ×= 12 times

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 TIME VALUE OF MONEY

UNIQUE QUESTION

Question :

Calculate future value at the end of 3 months, 9 months and 7

months, if Present value is ₹ 50,000. And rate of interest is
14%p.a. compounded annually.

Answer :

Given:-

P.V. = 50,000

r = 14%p.a.

End of 3 months F.V

F.V. =P.V.(1+r)n

= 50,000 ( 1 + 0.14 )n

How to find ‘n’ or power

12M 1
3M X

3×1 1
i.e. x = =
12 4

F.V = 50,000 (1 + 0.14)1/4


= 50,000 × (1.14)1/4

= 50,000 × 1.03329

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 TIME VALUE OF MONEY

Press √ 2 times

F.V. = 51664.97

End of the 9 months f.v.

F.V. = P.V.(1+r)n

= 50,000 × ( 1 + 0.14 )n

= 50,000 × (1.14)n

12M 1
9M X

9×1
i.e x=
12

3
=
4

F.V. = 50,000 (1 + 0.14)3/4

= 50,000 × [(1.14)3]1/4

= 50,000 × [(1.4815)]1/4

= 50,000 × 1.10326

F.V. = 55163.09

End of 7 months F.V.

F.V. = P.V. (1+r)n

PROF. ASHISH PARIKH UNIQUE ACADEMY 8007916633/22
 TIME VALUE OF MONEY

F.V. = 50,000 (1+0.14)n

= 50,000(1.14)n

12M 1
7M X

7
x =
12

i.e. F.V. = 50,000 (1.14)7/12

= 50,000 × 1.0794

F.V. = 53971.52

UNIQUE POINT

When any Investor Invest his money somewhere he always expects

something in return.

 Scarification of current consumption

 Inflation
 Risk Premium

 If rate of interest (r) = 12% p.a. compounded annually find 6 months rate of
interests.
 Here, We can’t say
12%
= 6%
2
This will be wrong

PROF. ASHISH PARIKH UNIQUE ACADEMY 8007916633/22

 TIME VALUE OF MONEY

Here,

12% (compounded annually)

12
+ 1 (1.12) ... factor
100

Meaning

If we invest ₹.1 today than we will receive after 12 months (1.12)

12M 1
6M X
6×1 1
i.e. x= =
12 2

Answer is 6 months rate of interest is (1.12)1/2

Effective Rate of Interest

Effective Rate of Interest means always compounded annually.

UNIQUE QUESTION

Question :

Now, You think in which Bank you going to invest your money.

Bank A – 18% p.a. (Nominal ROI) compounded monthly

Bank B - 19.2% p.a. compounded semi-annually
Bank C - 20% p.a. compounded annually

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 TIME VALUE OF MONEY

Be careful, here we can’t say more compounding more Benefit.

Because rate of interest are unequal

Therefore, our first target is to convert

Nominal ROI to Effective Rate Of Interest (compounded annually)

Answer :

Bank A
18% p.a. compounded monthly.

18%
= 1.5%
12

If we invest ₹ 1 today we than we will receive (1.5) after 1 month

1.5
+ 1 = (1.015)12 …converted into factor
100

1.1956 – 1

0.1956×100

i.e. 19.56

Effective ROI is 19.56

Bank B
19.2% p.a. compounded semi-annually

19.2
= 9.6%
2

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 TIME VALUE OF MONEY

If we invest Rs.1 today than we will receive (9.6) after 6 month

9.6
+ 1 = (1.096)2 …converted into factor
100

= (1.096)2

= 1.201216 – 1

= 0.201216×100

i.e. = 20.12%

Effective ROI is 20.12

Bank C

Bank C is already 20% p.a. compounded annually

Effective ROI is 20%

 Effective ROI converted into Nominal ROI (compounded monthly)

For e.g.

Effective ROI (v) = 19.56%

19.56
+ 1 = (1.1956)
100

F.V. = P.V. (1+r)n

r
1.1956 = 1 [( 1+ )12] …compounded monthly
12
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 TIME VALUE OF MONEY

r
∴ 1.1956 = 1 [( 1+ )12]
12

r
∴ (1.1956) 1/12
= (1 + )
12

r
∴ 1.0149 = (1 + ) …DIRTY power method
12

r
∴ 1.0149 – 1 =
12

r = 0.0149×12

r = 17.99%

i.e. r = 18%

ANNUITY
When you pay or receive equal amount on regular amount (interval)
that known as Annuity

For e.g.

Question :

r = 12% p.a.

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 TIME VALUE OF MONEY

Answer :

CASE 1

F.V.
T1 (P.V.) = P.V. =
(1+r)n

5000
P.V. =
(1+0.12)1

5000
=
(1.12)

{[T1 P.V] = 4464.28}

F.V.
T2 (P.V) = P.V =
(1+r)n

5000
P.V. =
(1+0.12)2

5000
= P.V. =
(1.12)2

{[T2 P.V] = 3985.96}

F.V.
T3 (P.V) P.V =
(1+r)n

5000
=
(1+0.12)3

5000
=
(1.12)3

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 TIME VALUE OF MONEY

{[T3 P.V.] = 3558.90}

F.V.
T4 (P.V) P.V =
(1+r)n

5000
=
(1+0.12)4

5000
=
(1.12)4

{[T4 P.V.] = 3177.59}

Now, T1 + T2 + T3 + T4

= 4464.28+3985.96+3558.90+3177.59

i.e. 15186.7

CASE 2
Present value of Annuity = 5000×PVA f (12%, 4)

Where as ,

PVAf -> Present Value Annuity factor

1
= 5000×[
(1.12)4

= 5000×3.037

P.V of Annuity = 15186.74

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 TIME VALUE OF MONEY

UNIQUE POINTS

 When you want to pull single amount it is always present

value factor/ Present value interest factor/ Discount factor.
 When you want to pull series of equal amount it is always
Present value annuity factor.
 If Annuity amount is starting from at the end of each year it
is known as “Regular Annuity”
[P.V of Annuity = Annuity × PVAf (r,n)]
 If Present value of annuity is given and you need to calculate the
annuity amount.

P.V. of Annuity
[ Annuity = ]
PVAf (r,n)

 If Annuity amount is starting from at the beginning of the period it is

known as “Annuity Due”.

For e.g.

r = 3%

1
P.V of Annuity = 1,00,000 + 1,00,000 [ ]
PVAf (r,n)

1
P.V of Annuity = 1,00,000 + 1,00,000 [ ]
(1.09)3

=1,00,000 + 1,00,000[2.5312]

=1,00,000 + 253129.46

[P.V of Annuity = 353129.46]

PROF. ASHISH PARIKH UNIQUE ACADEMY 8007916633/22
 TIME VALUE OF MONEY

UNIQUE QUESTION

Question :

Mr. Abhishek deposit ₹ 1,00,000 in a Bank Alc today. What amount

can be withdrawn at the end at each year for 10 years?
Take interest rate as 7%

Answer :

1
P.V of Annuity(x) = x × PVAf
PVAf (r,n)

1
1,00,000 = x ×
(1.07)10

1,00,000 = x × 7.02358

100000
= x
7.02358

i.e. x = 14237.75

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 TIME VALUE OF MONEY

FUTURE ANNUITY

In case of Regular Annuity,

A
F.V of annuity = [ (1+i)n – 1 ]
i

In case of Due Annuity,

A
F.V of annuity = [ (1+i)n – 1 ] (1+i)
i

If future value of annuity is given and you need to calculate the

Annuity Amount

𝑭.𝑽
[Annuity = ]
𝑭𝑨𝑽𝑨𝒇(𝒓,𝒏)
For e.g.
r = 7%
A
F.V of annuity = [(1+i)n-1]
i
5000
= [(1+0.07)4-1]
0.07
= 71428.57 [(1.07)4-1]
= 71428.57 [0.31079]

F.V of annuity = 22199.71

For e.g.

A
F.V of annuity = [ (1+i)n – 1 ] (1+i)
i

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 TIME VALUE OF MONEY

5000
= [(1+0.07)4-1] (1+0.07)
0.07
= 71428.57 [0.31079] × 1.07
= 22199.71 × 1.07

F.V of annuity = 23753.69

 An annuity is a streams of regular periodic payment made or

received for a specified period of time.
 In an ordinary annuity payment or receipts occurs at the end
of each period

SINKING FUND

It is the fund which is created for a specified purpose by way of

sequence of periodic payments over a time period at a specific interest
rate

UNIQUE QUESTION

Question :
PROF. ASHISH PARIKH UNIQUE ACADEMY 8007916633/22
 TIME VALUE OF MONEY

A firm has a Balance sheet ₹ 500 lakhs face value of debenture to be

redeemed after 10 years. What amount should be set aside at 8% p.a.
in the sinking funds.

Answer :
A
F.V. of Annuity = [ (1+i)n – 1 ]
i

x
500 L = [(1+0.08)10-1]
0.08

x
500 L= [1.1589]
0.08

500 L × 0.08 = x [1.1589]

40 L = x [1.1589]

40 L
= x
1.1589

x = 34.51 Lakh

 One of the most fundamental concept in finance is that Money

has a “Time Value”.
 That is to say that money in hand today is worth more than
money that is excepted to be received in the future.
 A rupee that you receive today can be invested in such a way
that you will have more than a rupee at same future time.

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 TIME VALUE OF MONEY

PERPETUITY
Perpetuity is the Annuity will continue forever.

A
Perpetuity = ...no growth firm
i

“ Koi bhi Asset ki aaj ki Price kya honi Chahiye”

Present value of future cash flows….

*Perpetuity is an annuity in which the periodic payment or receipts

begins on a fixed date and continue indefinitely or perpetually.
D
Perpetuity = …growth firm
(i-g)
500
= …[i>growth]
0.10 - 0.05

500
=
0.05

∴ Perpetuity = 10,000

PROF. ASHISH PARIKH UNIQUE ACADEMY 8007916633/22

 TIME VALUE OF MONEY

PROF. ASHISH PARIKH UNIQUE ACADEMY 8007916633/22