PERSONAL FINANCE

Module 2- Time Value of Money

 TIME VALUE OF MONEY
 The time value of money is a fundamental financial
principle that asserts that the money you possess today
holds greater value than the same amount in the future.
 This difference in value arises from its potential to earn
returns over time , and inflation diminishes the purchasing
power of future money.
 The essence of this concept lies in the idea that money can
generate income through investment, meaning that
postponing investment equates to missing out on potential
earnings.
 Generating inflation beating wealth is a crucial objective
for all investors. The idea behind this goal is quite simple:
as time goes on, the value of money depreciates.
 Understanding TVM helps you evaluate opportunities,
compare investment options, and make informed choices
about when to spend or save your hard-earned rupees.
 UNDERLYING REASONS

 The concept of time value of money is one of the

fundamentals that drive investment behavior in
the market. The reasons are

1. Earning and interest

2. Inflation

3. Uncertainty

4. Opportunity cost
1. Earning and interest
 Everyone works hard to grow their wealth over time.

 One of the primary ways to grow wealth is to park money

in savings and investment and earn interest income.
 This directly means that the more money in the present
you can grow it into even more wealth over time through
investments.
2. Inflation

 Inflation refers to the general rise in prices of goods and

services over a given period.
 It causes the value of money to decrease making the
present rupee in hand more valuable than the same rupee
in the future as its purchasing power would decrease.
 A major objective of investment is to overtime beat the
decrease in the value of money caused by inflation.
3. Uncertainty
 There is no certainty about the future.
 There is no guarantee that you will receive money in the
future.
 Thus, people tend to prefer having money in the present
over the assurance of possession in the future.
4. Opportunity cost
 if you have money in the present you have the luxury of
choice.
 You can choose to invest it or save it for financial venture
among a plethora of other avenues.
 It may not be possible to have concrete plans if money is
not present today but it is only assured for the future.
 SIMPLE VS COMPOUND INTEREST
 Simple Interest:
 Interest is calculated only on principal.

 Compound Interest:
 Interest is calculated on principal plus
accumulated interest.
 CORE CONCEPTS OF TVM
1. Present Value (PV): The current worth of a future sum of money,
discounted at a specific rate.
2. Future Value (FV): The value of a current sum of money at a
future date, after earning interest.
3. Interest Rates: The cost of borrowing money or the return on
investment (simple or compound).
4. Discount Rate: The rate used to calculate the present value of
future cash flows.
5. Time Period (n): The number of periods (years, months) your
money compounds and grows.
6. Compounding and Discounting: Processes of moving money
forward (compounding) or backward (discounting) in time.
 Present
Value

Future
Value

CONTEN
Content
Annuities Present Value
of a Annuity
Future
Value
of a
Annuit

T Annuities
Present
Value of
a
y
Future
Value of
an
Due Annuity Annuity
Due
Due

Perpetuities
 PRESENT VALUE (PV) CONCEPT
• Present Value is the current worth of future money
discounted at a specific rate.
 Formula: PV = FV / (1 + r)^n
 FUTURE VALUE (FV) CONCEPT
 Future Value is the value of current money at a future
date after earning interest.
 Formula: FV = PV (1 + r)^n
 QUESTION
Ques 1: An individual is offered ₹10,000 immediately or
₹13,310 at the end of 3 years. If the rate of discount is
10 per cent per annum, advise which alternative
should be accepted.
Ques 2: An investor can either receive ₹20,000
immediately or ₹29,282 after 4 years. If the
opportunity cost of capital is 10 per cent per annum,
which alternative should be preferred?
Ques 3: You will receive ₹1,00,000 from a Fixed
Deposit (FD) maturing in 6 years. If the discount
rate is 8% per annum, what is the present value of
this amount today?

PV=FV×PVFr,n

PV= ₹1,00,000 ×PVF 8%,6

PV= ₹1,00,000 × 0.630*

PV= ₹63,000

Note:-*Value taken from PVF table

Ques 4: A sum of ₹15,000 is invested for a period of 4
years at an interest rate of 8 per cent per annum,
compounded annually. Calculate the amount
accumulated at the end of the period.
FV= 15,000 (CVF8%,4)
FV = 15,000 (1.360)
FV = 20,400
Ques 5: What will be the future value of ₹25,000
deposited now at 12 per cent per annum for 3 years,
assuming annual compounding?
FV= 25,000 (CVF12%,3)
FV = 25,000 (1.405)
FV = 35,123
Ques: 6 You invest a lump sum of ₹1,00,000 in a Fixed
Deposit (FD) with a bank offering an interest rate of 8%
per annum for 6 years. What will be the future value of
this investment, assuming annual compounding?
FV=PV×(CVF r, n)

FV= ₹1,00,000 ×(CVF 8,6)

FV= ₹1,00,000(1.587)*

FV= ₹1,58,700

Note:-*Value taken from CVF table

 Ques 7: Savings for Education

 Scenario: A parent plans to save for their child’s college education, which
is expected to cost ₹20 lakhs in 10 years. Interest Rate- 8%

 The parent needs to invest approximately ₹9,26,395 today at 8% annual

interest.

 Ques 8 2: Fixed Deposits (FDs)

 Scenario: An individual invests ₹1 lakh in an FD offering 6.5% interest

compounded annually for 5 years.

 The maturity amount will be approximately ₹1,37,010.

Ques: A sum of ₹10,000 is invested at a nominal interest
rate of 12 per cent per annum, compounded semi-
annually, for a period of 3 years. Determine the amount
to which the investment will accumulate at the end of
the period.
Solution
Given:
Principal (PV) = ₹10,000
Nominal rate of interest = 12% p.a.
Compounding frequency = Semi-annual
FINANCIAL CALCULATOR
ANNUITY
 An annuity refers to a series of equal cash
flows occurring at regular intervals over a
specified period.
 Cash flows may be received or paid.

 Examples:
1. Loan EMIs
2. Pension payments
3. Insurance premiums
4. Systematic investment plans (SIP)
Ordinary Annuity
1. Rent paid at the end of the month
2. Annual interest received at year-end
Formula for Future Value of Annuity:

FV=PV×(CVAF r, n)

Eg:- Suppose you invest ₹10,000 annually (A = ₹10,000)

in a Recurring Deposit (RD) with a bank offering an
interest rate of 7% per annum (r = 0.07) for 5 years (n =
5). Let’s calculate the future value of this annuity.

FV=PV×(CVAF r, n)
FV= ₹10,000 ×(CVAF 7,5)

FV= ₹10,000 ×(5.751)*

FV= ₹57,510

Note:- *Value taken from CVAF table

QUES: Patricia Beck expects to receive $10,000 per year for
the next five years, starting one year from now.

If the cash flows can be invested at 10% per annum, how

much will she have after five years?
 1+𝑟 𝑁 −1
𝐹. 𝑉. = 𝐴 ∗ [ ]
𝑟

1+.1 5 −1
𝐹. 𝑉. = 10000 ∗ [ ] ; 1 + .1 5
= 1.61051
.1

.61051 .61051
PV = 10000 * .1
; .1
= 6.1051

= 10000 * 6.1051

= $ 61051

FV = A (CVAF r,n)

FV = 10,000 (CVAF 10%, 5)

FV= 10,000 (6.1051)

FV = 61,051
Ques: How much do you need to save per month to
get $20,000 in 4 years at an 8% p.a. return.
Compounded monthly.
 FV=A (CVAF r,n)

 20,000 = A (CVAF 0.0067, 48)

 20,000 = A (56.4)

 354.61 = A
Formula for Present Value of Annuity:

PV=PMT×PVAFr,n

QUES : You are offered a savings scheme (e.g., an annuity-

based insurance plan or a Post Office Monthly Income
Scheme) that pays ₹15,000 annually for 6 years. If the
appropriate discount rate is 8% per annum, what is the
present value of these payouts today?

PV=PMT×PVAFr,n
PV= ₹15,000 × PVAF 8%, 6

PV=₹15,000 (4.623)*

PV= ₹69,345

Note:- *Value taken from PVAF table

 Example

Apex Corporation is offering an instrument that promises to

pay $1,000 per year for 20 years, beginning one year from
now.

If the annual rate of interest is 5%, what is the present value

of the annuity?
 1−1/ 1+𝑟 𝑁
P. 𝑉. = 𝐴 ∗ [ ]
𝑟

1−1/ 1+.05 20
P. 𝑉. = 1000 ∗ [ ] ; 1/ 1 + .05 20
= 0.3769
.05

.6231 1 −0.3769
PV = 1000 * ; = 12.46
.05 .05

= 1000 * 12.46
= $ 12,460

PV = A (PVAF r,n)
PV = 1000 (PVAF 5%,20)
PV = 1000 (12.46)
PV = 12,462
NORMAL CALCULATOR CALCULATIONS
 PVF = +2
 CVF = +1

 PVAF = +2; GT

 CVAF = same as n; GT; +[Link]

 ANNUITIES DUE

 Annuities Due are annuities

where payments are made at the
beginning of each period.
 Commonly used in leases, rent
agreements, and insurance
premiums.
FORMULA
 How to calculate Annuity Due using Financial
Calculator:
 2nd → BGN

 2nd → SET (to turn BGN on)

 2nd → CPT (to return)

 EXAMPLE

 David Mathew has just bought an insurance policy. The annual

premium is $12,000, and he is required to make 25 payments. What
is the present value of this annuity due if the discount rate is 10%
per annum?
 SOLUTION:
𝐴 1
 𝑃𝑉 = 1 − ∗ (1+r)
𝑟 1+𝑟 𝑁

12000 1
 𝑃𝑉 = [1 − ] ∗ (1+.1)
0.1 1+.1 25
 =$ 119,816.93

 PV = 12000 (PVAF 10%, 25 ) (1+.1)

 PV = 12000 (9.077) (1.1)

 PV = 12000 (9.9847)

 PV = 119,816
 EXAMPLE

 David Mathew has just bought an insurance policy. He pays $12,000 at the
start of each period for annual premium , and he is required to make 25
payments. The rate of interest is 10%. In the case of Mathew’s insurance
policy, what will be the cash value at the end of 25 years?
 SOLUTION
1+𝑟 𝑁 −1
 𝐹. 𝑉. = 𝐴 ∗ [ ] * (1+r)
𝑟

1+.1 25 −1
 = 12000 ∗ [ ] * (1+.1)
.1

 = $1,298,181.19

 FV = A (CVAF r, n ) (1 + r)

 FV = 12000 (CVAF 10% ,25) (1 + .1)

 FV = 12000 (98.34 ) (1.1)

 FV = 12000 (108.18)

 FV = 12,98,181
 PERPETUITIES

 An annuity that pays forever is called a perpetuity.

𝑨
 Present Value of a Perpetuity =
𝒓
 EXAMPLE
 Consider a financial instrument that promises to pay $1,000 per year
forever.

 If you require a 20% rate of return, how much should you be willing to pay
for it?
 SOLUTION

𝐴
 Present Value of a Perpetuity = 𝑟

1000
 Present Value of a Perpeuity = 0.2
= $5000
Why TVM Matters in Real Life

Loan Decisions Retirement Planning Investment Choices Inflation Protection

Compare EMI options and Calculate how much to save Evaluate returns across Understand how inflation
understand the true cost of today to achieve your different investment vehicles erodes purchasing power and
borrowing over time. retirement goals decades from and time horizons. plan accordingly.
now.

[Link]
 Mr. Ashok has been given three retirement options. First option is
receiving Rs. 10 lakhs in lumpsum now. The second option is to receive
constant amount of Rs. 150000 per annum for the next 10 years. Third
option is to receive Rs. 50000 per annum forever. His CA, Mr. Agnihotri
recommends that Mr. Ashok should go ahead with the second option
as it ensures regular income for a decade. Do you agree? Assume
discount rate to be 9%. Explain showing necessary calculations.
 Solution-
1. Option 1 (Lumpsum Rs. 10 Lakhs Now):
Present Value = Rs. 10,00,000
2. Option 2 (Rs. 150,000 Per Year for 10 Years):
Present Value = Rs. 9,62,648
3. Option 3 (Rs. 50,000 Per Year Forever):
Present Value = Rs. 5,55,555.56
 Sarah is a 25-year-old professional who just started her career. She is planning for her
retirement and wants to start saving early to ensure a comfortable lifestyle in her later years.
She decides to invest $1,000 per year in a retirement account until she turns 65. Sarah expects
an average annual return of 8% on her investments.
1. If Sarah plans to retire at the age of 65 and starts investing $1,000 at the end of each year, how
much will she have in her retirement account when she retires?
2. What if Sarah decides to delay her retirement savings plan and starts investing the same
amount at the end of each year but starts at the age of 35 instead of 25? How much difference
does this 10-year delay make in her retirement savings?
3. If Sarah wants to know how much she needs to invest today to have $1,000,000 in her
retirement account when she turns 65, given an 8% annual return?
4. Sarah hears about a more aggressive investment option that promises a higher average annual
return of 12%. How would this impact her future retirement savings compared to the initial
plan with an 8% return? What are the risks associated with a higher return?
 These questions can help Sarah understand the importance of starting to save early, the impact
of time on the value of money, the relationship between risk and return, and the need to
consider long-term financial planning. This caselet illustrates various aspects of the Time Value
of Money and its application in real-life financial decisions.
 Ans Key:- 1.- 2,59,056; 2.- 1,13,283; 3.- 46,030; 4.- 7,67,091
 John and Jane are a couple in their early 30s (assume 30yr old) who are keen on achieving their financial
goals. They have several major life events they are planning for and want to use the Time Value of Money
concept to make informed decisions.
1. Buying a House: John and Jane are planning to buy their first house in 5 years. The house they want costs
$300,000. If they can earn a 6% annual return on their savings, how much should they start saving each
month from now to have the required payment in 5 years?
2. Education Fund for Children: The couple has a 1-year-old child, and they want to start saving for the child's
education. They estimate that the cost of a college education will be $150,000 in 18 years. If they invest in
an account with an expected annual return of 7%, how much should they invest each year to have the
required amount when their child turns 18?
3. Retirement Planning: John and Jane are aware of the importance of saving for retirement. They want to
retire at the age of 65 and estimate that they will need $1,500,000 for a comfortable retirement. If they
start saving $10,000 annually in a retirement account with an expected annual return of 8%, will they have
enough by the time they retire?
4. Emergency Fund: The couple also wants to build an emergency fund for unexpected expenses. They aim to
have $20,000 in their emergency fund in 3 years. If they can earn a 5% annual return, how much should they
set aside each month to reach their goal?
 This caselet helps John and Jane apply the Time Value of Money concept to various aspects of their financial
planning, such as saving for short-term goals, long-term goals, and evaluating investment options. It
emphasizes the importance of considering the time value of money in making financial decisions to ensure
they meet their financial objectives.
 Ans Key:- 1.- 4,299; 2.- 4,411; 3.-17,23,168; 4.- 516
 Buying a House vs Investing: A Financial Decision
 Rahul is 30 years old and is evaluating whether to buy a house or continue renting.
 He has the financial capacity to spend ₹25,000 per month toward housing for the
next 20 years.
 He is considering two options:
 Option A: Buy a House
 Rahul purchases a house using a home loan that requires an EMI of ₹25,000 per
month for 20 years.
 Assume that at the end of 20 years, the net realizable value of the house is ₹1 crore.
 Option B: Rent and Invest
 Instead of buying, Rahul decides to rent a house and invest ₹25,000 per month in a
mutual fund SIP earning 12% p.a. compounded monthly for 20 yrs.
 Questions
1. How much wealth will Rahul accumulate under Option B?
2. Which option is financially superior based purely on numbers?
3. What non-financial factors might influence Rahul’s decision?
 Option A (House)
 Wealth after 20 yrs = ₹1 crore
 Option B (SIP)
 Wealth after 20 yrs = ₹2.47 crore
 Pure Financial Conclusion
 Option B (Rent + SIP) creates:
 ₹1.47 crore more wealth
 So numerically, Option B is superior.
1) Liquidity
SIP → Highly liquid
House → Illiquid
2) Risk
SIP → Market risk
House → Property market risk
3) Behavioral Factors
Emotional security of owning a home
Social prestige and Cultural bias toward real estate
4) Hidden Assumptions
Constant 12% return?
Property only ₹1 crore after 20 yrs?
No rent escalation?
“Buying a house is partly a financial decision and partly a lifestyle
decision. The best choice depends on both numbers and personal
priorities.”
 Riya (age 28) wants to take a 2-year career break
for higher studies. She currently saves ₹80,000
per year earning 10%.
1. If she continues saving for 30 years, how much
will she accumulate?
2. If she pauses savings for 2 years, how much less
will she have?
3. How much extra must she invest annually after
the break to catch up?
3. 98,051