Time Value of Money - 1

FINANCIAL MANAGEMENT - I

Time Value of Money An

Introduction
Rs. 1,000 received now is more valuable than

Rs. 1,000 received 1 year later

Why should money have time value?

Inflation erodes purchasing power of money over

time - Rs. 100 has a higher purchasing power today
than a year later
Money has an opportunity cost
Individuals prefer consumption today over
consumption later

Process of Compounding Vs.

Simple Interest Scheme
End of Compounded Interest
Year
Scheme

Simple Interest Scheme

01

1000 + (1000 x 0.10) = 1100

1000 + (1000 x 0.10) = 1100

02

1100 + (1100 x 0.10) = 1210

1100 + (1000 x 0.10) = 1200

03

1210 + (1210 x 0.10) = 1331

1200 + (1000 x 0.10) = 1300

04

1331 + (1331 x 0.10) = 1464

1300 + (1000 x 0.10) = 1400

05

1464 + (1464 x 0.10) = 1610

1400 + (1000 x 0.10) = 1500

Process of Discounting
End Compounded Interest Scheme Start
of
of
Year
Year
01
02

03
04
05

Discounting Scheme

01

1100 /(1 + 0.10) = 1000

02

1210 /(1 + 0.10)2 = 1000

03

1331 /(1 + 0.10)3 = 1000

04

1331 /(1 + 0.10)4 = 1000

05

1464 /(1 + 0.10)5 = 1000

1000 + (1000 x 0.10) = 1100

1100 + (1100 x 0.10) = 1210

1210 + (1210 x 0.10) = 1331

1331 + (1331 x 0.10) = 1464
1464 + (1464 x 0.10) = 1610
4

Future Value of Money Deposited

Today (Example 1)
The Municipal Co-Operative Bank Ltd.

offers 9 % p.a. interest compounded

annually on deposits of 1 year and more.
What is the value of Rs. 100,000
deposited today after 3 years from today?

Future Value of Money Deposited

Today (Solution to Example 1)
FVn = PV (1 + k)n
FV3 = 100,000 x (1 + 0.09)3

= 100,000 x 1.295
= Rs. 129,500

Doubling Period (Example 2)

How long will it take to double Rs. 1000

invested today @ 7 % p.a. interest?

Doubling Period
to Example 2)

(Solution

Rule of 72:
72/ 7 = 10.3 years (Rounded to 10 years)

Rule of 69:
0.35 + 69/7 = 0.35 + 9.86 = 10.3 year

And, (1 + 0.07)10 = 1.967

Future Value with Increased Frequency of

Compounding (Example 3)

What is the value of Rs. 1000 deposited at

the beginning of this month for 5 years in

a bank @ 6 % p. a. compounded quarterly
basis?

Future Value with Increased Frequency of

Compounding (Solution to Example 3)

FVn = PV (1 + k/m)m x n, where

m = No. of compounding
annually
k = Annual rate of interest
FVn = 1000 (1 + 0.06/4)4x5
= 1000 x (1.015)20
= 1000 x 1.3468 = 1,346.8
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Effective Vs. Nominal Rate of

Interest (Increased Frequency of Compounding)
r = (1 + k/m)m - 1
r = (1 + 0.06/4)4 - 1 = 1.06136 1
0.06136 or 6.14 %

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Future Values of Multiple Flows

9862
5000

5000 x 1.06 =

5,300

3000

3000 x (1.06)2 = 3000 x

1.1236 = 3371

1000

1000 x (1.06)3 = 1000

x 1.191

= 1191

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