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Class notes and derivation of TVM equations. Anand 2011. All rights reserved.
Cash Flow
(Observed/Expected)
Single CF
Multiple CF
Future Value
Present Value
Fluctuating CF (Finite
without growth...why?)
Constant C.F.
=C*FVFk,n
=C*PVFk,n
Future Value
Present Value
=c*((1+r)^n-(1+g)^n)/(rg)
=c/(r-g)*(1((1+g)/(1+r))^n)
Future Value...Only if
you know CF or their
patterns in
blocks/phases.
Infinite CF Series:
Growing Perpetuity
Future Value...
Indeterminable...why?
Infinite Series:
Perpetuity
Present Value
Future Value
Present Value
Present Value
=C/(r-g)
=C*FVIFAk,n
=C*PVIFAk,n
=c/r
Present Value...Only if
you know CF or their
patterns in
blocks/phases.
3
The annuity tables give us values of PVIFA and FVIFA for a series of combinations of interest rates and
periods (k,n). An important thing to remember while applying those table values for PVIFA and FVIFA to
different problem sets is that they are calculated assuming an Ordinary Annuity of the following type
(Salary, Interest on bond, Cash Flow at the end of the period):
Time
CF
n-1
Where the PV would be calculated at time zero and future value would be calculated at time n.
But in case the problem has the following type of cash flow described as Annuity Due (Insurance
premium, rent, Cash Flow at the beginning of the period),
Time
CF
n-1
The above mentioned factors are required to be adjusted for one period of excess discounting (PVIFA)/
one period of under compounding (FVIFA) in the in the ordinary annuity compared to the Annuity Due.
Therefore in case of application of PVIFA for getting Present value of Annuity Due, since the PVIFA value
is discounted for an additional period (from 1 to 0) compared to ordinary annuity CF pattern, we would
need to remove effect of that excess discounting by compounding PVIFA by one period. This can be
easily achieved by multiplying PVIFA with (1+r).
=c*PVIFAk,n*(1+r)
In case of Future value of Annuity Due as well, the FVIFA value would be required to be compounded for
one more period (from n-1 to n) by multiplying FVIFA with (1+r). This is because the ordinary annuity
compounds CF only until the last CF where as in case of Annuity Due we need to compound the CF until
one period after the last CF.
=c*FVIFAk,n*(1+r)
TVM formula derivation
Future value after 1 period
PV0*(1+r) = FV1
(1)
FV1*(1+r) = FV2
(2)
(3)
PV0*(1+r)n= FVn
(4)
Class notes and derivation of TVM equations. Anand 2011. All rights reserved.
4
Dividing both sides by (1+r)n we have
PV0*(1+r)n/(1+r)n = FVn*1/(1+r)n
PV0= FVn*1/(1+r)n
(5)
(6)
(Notice that the above series is compounding till n-1 periods only)
Multiplying both sides by (1+r) we get FVAn*(1+r)=C*(1+r)n+ C*(1+r)n-1+ +C*(1+r)2+C(1+r)
(7)
FVAnr=C*[(1+r)n-1]
(8)
FVAnr/r=C*{(1+r)n-1}/r
(9)
FVAn=C*[{(1+r)n-1}/r]
(10)
The second term on the RHS of the equation in also given as FVIAF for a given r and n.
Present Value of Ordinary Annuity (PVA)
(11)
(12)
PVAnr=C*{1-(1+r)-n}
(13)
Or, PVAnr=C*{1-1/(1+r)n}
(14)
PVAnr*(1/r)=C*{1-1/(1+r)n}*1/r
(15)
PVAn=C*{1-1/(1+r)n}*1/r
(16)
In some books (Eg. PC) an alternative derivation of similar nature could be found taking from (13)
We can rewrite the equation as
PVAnr=C*[{(1+r)n-1}/(1+r)n]
(14.1)
PVAn=C*[{(1+r)n-1}/r(1+r)n]
(15.1)
PVAn=C*[{1-(1/(1+r)n}/r]
(16.1)
In either case, the second term on the RHS of the equation (16) or (16.1) is given by the annuity table as
PVIAF for a given r and n.
If you need to calculate Present or future value of annuity due using PVIFA or FVIFA tables, you need to
multiply it by (1+r) to adjust its value for one period.
Present value of a perpetuity
Class notes and derivation of TVM equations. Anand 2011. All rights reserved.
(17)
5
Multiplying both sides of (17) with (1+r) we get PV0*(1+r)= C+ C*(1+r)-1+ C*(1+r)-2+
(18)
PV0r= C
(19)
PV0r*(1/r)= C*(1/r)
(20)
PV0= C/r
(21)
..
Suggestions to update/improve/correct the above document for any deficiency is welcomed and would
be appreciated by the author. Anand 2011. All rights reserved.
Email: anand.ibsh@gmail.com
Class notes and derivation of TVM equations. Anand 2011. All rights reserved.