Would you prefer to have Rs 1 million now or Rs 1 million 10

years from now?

Time preference for money is an individuals preference for
possession of a given amount of money now, rather than the same
amount at some future time.
Three reasons may be attributed to the individuals time
preference for money:
risk
preference for consumption
investment opportunities
Money has a time value because it can earn more money over time
(earning power).
Money has a time value because its purchasing power changes
over time (inflation).
Time value of money is measured in terms of interest rate.
What is Time Value of Money
Delaying Consumption
Account Value Cost of Refrigerator
Case 1: Inflation exceeds
earning power
N= 0 Rs 100
N = 1 Rs 106
(earning rate = 6%)
N= 0 Rs 100
N = 1 Rs 108
(earning rate = 8%)
Case 2: Earning power
exceeds inflation
N= 0 Rs 100
N = 1 Rs 106
(earning rate = 6%)
N= 0 Rs 100
N = 1 Rs 104
(earning rate = 4%)
You have three choices:
Rs 20,000 received today
Rs 31,000 received in 5 years
Rs 3,000 per year indefinitely
To make such comparisons, we must be able to compare the value
of money at different point in time.
To do this, we need to develop a method for reducing a sequence
of benefits and costs to a single point in time.
Cannot directly compare Rs 1 today with Rs 1to be received at
some future date
Money received today can be invested to earn a rate of return.
Thus Rs1 today is worth more than Rs1 to be received at some
future date.
Choosing from Different Alternatives
Two most common methods of adjusting cash flows for time value
of money:
Compoundingthe process of calculating future values of cash
flows and
Discountingthe process of calculating present values of cash
flows.


A timeline is a graphical device used to clarify the timing of the
cash flows for an investment
Time Value Adjustment
Timelines
Suppose that you have an extra Rs 100 today that you wish to
invest for one year. If you can earn 10% per year on your
investment, how much will you have in one year?



If you deposit Rs 55,650 in a bank, which was paying a 15 per cent
rate of interest on a ten-year time deposit, how much would the
deposit grow at the end of ten years?
We will first find out the compound value factor at 15 per cent for
10 years which is 4.046. Multiplying 4.046 by Rs 55,650, we get Rs
225,159.90 as the compound value.
Future value of a Lumpsum
10, 0.12
FV 55,650 CVF 55,650 4.046 Rs 225,159.90 = = =
Compound Value factor of a lumpsum of Re 1
Annuities
An annuity is a series of nominally equal payments equally
spaced in time
Annuities are very common:
Rent
Mortgage payments
Car payment
Pension income
The timeline shows an example of a 5-year, $100 annuity

(1 ) 1
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What will be the future value of Rs 100 annuity for 5 years? Rate
of interest is 10% per annum.





Suppose that a firm deposits Rs 5,000 at the end of each year for
four years at 6 per cent rate of interest. How much would this
annuity accumulate at the end of the fourth year?
We first find CVFA which is 4.3746. If we multiply 4.375 by Rs
5,000, we obtain a compound value of Rs 21,875:
Future value of an Annuity
4 4, 0.06
5,000(CVFA ) 5,000 4.3746 Rs 21,873 F = = =
Sinking fund is a fund, which is created out of fixed payments
each period to accumulate to a future sum after a specified
period. For example, companies generally create sinking funds to
retire bonds (debentures) on maturity.
The factor used to calculate the annuity for a given future sum is
called the Sinking Fund Factor (SFF).



ABCL company has issued debentures of Rs 50 lakhs to be repaid
after 7 years. How much should the company invest in a sinking
fund earning 12% in order to be able to repay debentures?

Sinking fund
=
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