Time Value of Money Rational

In this chapter…

Techniques… Practical application of compounding

and present value techniques…

Time Value of Money…

A rupee that is receivable today is more valuable than a rupee receivable in future.

Put in simple words, to days money is more valuable was future money.

Time Value of Money…

Time value of money is an individual’s preference for procession of a given amount of money now, rather than same amount at some future time.

There are mainly three reasons for the time preference of money: Risk Preference for consumption. Investment opportunities.

Techniques…

Future Value Present Value Multi Period Compounding.

Future Value…

Simple Interest. Compound interest. Annuity. Sinking fund.

Simple Interest…

SI = (P).(i).(n) Where;

SI= Simple Interest. P = Principle Amount. i = Rate of Interest. n = Number of years for which interest is

calculated.

Compound Interest…

CV = Po (1 + I)n

Where; CV = Compound value Po = Principal amount

I= Interest per annum n= Number of years for which compound is

done.

Variable compounding periods…

CVn = Po

Where; CVn = Compound value at the end of year ‘n’

Po= Principle amount at the year ‘0 I = Interest rate per annum m = Number of times per year compounding is done n = Maturity period

nm

M

I1

×

+

Future Value of an Annuity…

Annuity is a fixed payment each year for a specified number of years.

Formula is;

Fn = A

−+i

i n 1)1(

Sinking Fund…

Sinking Fund is a fund which is created out of fixed payments each period to accumulate to a future sum after a specified period.

A = ]1)1(

[−+ nn i

iF

Present Value…

Single Cash Flow Annuity. Capital Recovery & Loan Amortization. Perpetuity.

Single Cash Flow…

P =

OR

P = F

ni

F

)1( +

])1(

1[

ni+

Present Value of Annuity…

P = ]

)1(

11[

niiiA

+−