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OUTLINE
Why Time Value
Time Line
Part A 0 12% 1 12% 10,000 10,000 2 12% 10,000 3 12% 10,000 4 12% 10,000 5
Part B
0
12% 10,000
1
12% 10,000
2
12% 10,000
3
12% 10,000
4
12% 10,000
Notation
PV : Present value FVn : Future value n years hence Ct A r g n : Cash flow occurring at the end of year t : A stream of constant periodic cash flow over a given time : Interest rate or discount rate : Expected growth rate in cash flows : Number of periods over which the cash flows occur.
1,100
1,100 110 1,210 1,210
121 1,331
The process of Investing money as well as reinvesting the interest earned is called compounding. The future value or compound value of an investment after n years when the interest rate is r percent is: FORMULA FUTURE VALUE = PRESENT VALUE (1+r)n (Future value Interest factor / Future value factor)
4
6 8 10
1.574
1.689
6
8 10 12
0.705
0.626 0.558 0.497
0.630
0.540 0.463 0.397
0.565
0.467 0.386 0.319
0.507
0.404 0.322 0.257
0.456
0.351 0.270 0.208
Data : Calculate PV of Rs 1000 receivable 20 years hence if the discount rate is 8%? (Ans 214.54)
A2
+ +
An
(1 + r)n
Year 1 2 3 4 5 6 7 8
+
1,100 = 1000 X (1.1)^ 1
1,464
Rs.6,105
1000 X (1.1)^ 4
(1+r)n-1 r
Future value Interest factor of an Annuity (FVIFAr,n)
= Rs.30,000 [ 199.0209]
= Rs.5,970,626
(1+0.12)5 - 1
FVIFA n=5, r=12% = 0.12 The annual savings should be : Rs.20,00,000 = Rs.314,812.81 6.353 = 6.3528
years until you find a value close to 8.000. Doing so, we find that
FVIFA12%,6 is 8.115So, we conclude that the interest rate is slightly below 12 percent.
1.12n - 1 =
1.12n n log 1.12 n = = =
n x 0.0492 = 0.0492
909.1
826.4
751.3 2486.6 Present Value
6.210
5.747
5.335
6.145 6.814
4.968
5.650 6.194
4.639
5.216 5.660
How much you can borrow for a Car: You can afford to pay Rs 12000 per month for 36 months at 1.5 % per month. (Ans PVIFA = 27.6607, 331928.2 )
5
a
259,422 298,312
38,913
259,399
23*
Interest is calculated by multiplying the beginning loan balance by the interest rate.
b. Principal repayment is equal to annual instalment minus interest. * Due to rounding off error a small balance is shown
Annuity Due
A 0 A
Annuity due
Ordinary annuity
A 2 A 2
A n1
A n
1 A 1
A n1 n
Thus,
Annuity due value = Ordinary annuity value (1 + r) This applies to both present and future values. So two steps are involved in calculating the value of an annuity due. First calculate the present or future value as though it were an ordinary annuity Second multiply your answer by (1 + r)
A perpetuity is an annuity of Infinite duration. Present value of a perpetuity is simply equal to the constant annual payment divided by the interest rate.
r
The present value of a perpetuity of Rs 10,000 if the interest rate is 10% = 10,000/0.1 = Rs 100,000.
mxn
= Rs.10,164
Example PV: RS 5,000 ,12 percent ,quarterly, 6years PV = Rs 5,000 X PVIF(12/4) , (6x4) = Rs 5000 x 0.4919 = Rs 2459.66
percent per annum.The figure of 12.36 percent is called the effective interest rate the rate
of interest under annual compounding which produces the same result as that produced by an interest rate of 12 percent semi annual compounding.
m -1
QUESTION
Q) A 12 payment annuity of Rs 10,000 will begin 8 years hence.( The first payment occurs at
the end of 8 years).What is the Present value of this annuity if the discount rate is 14 percent? Ans Step No 1 - Rs 10,000 (PVIFA 14% , 12 years) = Rs 10,000 (5.660) = Rs 56,600
Hint: The present value for a perpetual annuity is derived by dividing the constant annual
flow by the discount factor? Ans The present value of the income stream is: 2,000 x PVIFA (10%, 5 years) + 3000/0.10 x PVIF (10%, 5 years)
QUESTION
Q) As a winner of a competition you can choose one of the following prizes:
a) Rs 5,00,000 now b) Rs 1,000,000 at the end of 6 years c) Rs 60,000 a year forever
Ans
a)
(b) (d)
PV = Rs.500,000
PV = 1,000,000 PVIF10%,6yrs = 1,000,000 x 0.564 = Rs.564,000 PV = 100,000 PVIFA10%,10yrs = 100,000 x 6.145 = Rs.614,500
(e)
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