[Link].

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Asst. Professor, Department of Management

UNIT-2
TIME VALUE OF MONEY

INTRODUCTION

‘A bird in hand is worth two in the bush’ – this adage applies to financial transactions too.
Say, someone borrowed a certain amount from you and it is due. Just as you are expecting the
money to be credited to your account, you get a call from the borrower saying that he will
pay you after 3 months. You are not happy about this. This is because you are aware of time
value of money or TVM, albeit subconsciously.

There is no reason
ason for any rational person to delay taking an amount owed to him or her.
More than financial principles, this is basic instinct. The money you have in hand at the
moment is worth more than the same amount you ‘may’ get in future. One reason for this is
inflation
nflation and another is possible earning capacity. The fundamental code of finance maintains
that, given money can generate interest, the value of a certain sum is more if you receive it
sooner. This is why it is called as the present value.

Basically, the
he time value of money validates that it is more beneficial to have cash now than
later. Say, if you invest a Rs. 100 today – the returns will be more compared to the same
investment made 2 months from now. Moreover, there is always a risk that the borrowe borrower
might delay even more or not pay at all in the future.
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Asst. Professor, Department of Management

CONCEPT OF TIME VALUE OF MONEY:

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Asst. Professor, Department of Management

MEANING OF TVM:-

The term “Time Value of Money” refers to the Money’s worth varies according to the time
period in which it is received.

REASONS FOR THE TIME PREFERENCE FOR MONEY:

MONEY:-

1. Uncertainty and loss.

2. To satisfy present needs.

3. Investment opportunities.

4. Inflation.

5. Consumption.

NEED/ APPLICATION/ IMPORTANCE OF TVM:

TVM:-

1. In Investment Decision.

2. In Capital Budgeting Decision.

3. It helps in personal decisions like savings for children, buying a house etc.,

4. It helps in accepting or rejecting project proposal.

5. Assessment of credit policies.

6. Determining the magnitude of risk & Uncertainty.

7. Finding out the implicit rate of interest.

8. Finding out the number of periods.

TECHNIQUES OF TIME VALUE OF MONEY:

MONEY:-

Techniques
of TVM
Compounding Discounting
Technique Technique
*Future value of Single cash flow
*Present value of Single cash flow
*Future Value of even cash flow *Present Value of Uneven cash flow
*Future Value of Uneven cash flow *Present Value of Uneven cash flow
*Future value of Annuity *Present value of Annuity
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Asst. Professor, Department of Management

MEANING OF PRESENT VALUE:

VALUE:-

It refers to the current worth of a future sum of money or stream of cash flows given a
specified rate of return.

MEANING OF FUTURE VALUE:

VALUE:-

It refers to the value of an asset or cash at a specified date in the future that is equivalent in
value to a specified sum today.

MEANING OF ANNUITY:-

It is a sum of money or an investment that is paid at regular intervals.

A. COMPOUNDING TECHNIQUE.

i)) Future value of Single cash flow

FVn = PV (1+r) n
Where,
FVn = Future value
PV = Present value
r = rate of Interest
n = No. of years

Problem- 01

Calculate the future value of a sum of Rs.1000 if it is invested at 8% interest for a period of 1
year.
Solution:-
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Asst. Professor, Department of Management

Problem- 02

Calculate the future value of a sum of Rs. 5000 if it is invested at 12% interest for a period of
3 years.
Solution:-

Problem- 03

Mr. X invests Rs.1000 for a period of 5 years in a Bank. The rate of interest is 10%. Find the
Future value.
Solution:-
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Asst. Professor, Department of Management

Multiple Compounding Periods

If a sum of Money is compounded for 1 year at a particular rate of interest then above
illustration help us to find the future Value.
But if the compounding period differs, interest earned will also differ if the interest is
compounded Semi annually, Quarterly or monthly; such future value is calculated by using
the following formula:

FV = PV [1 + r/m]mn

Where,

FV = Future Value
PV = Present Value i.e., cash flow
r = Rate of Interest
n = Total no. of years
m = No. of times interest is compounded in a year

Problem-04

Calculate the future value of a sum of Rs.1000 if it is invested for a year with an interest
compound period of Semi-annually, Quarterly and Monthly at 10%.
Solution:-
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Asst. Professor, Department of Management
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Asst. Professor, Department of Management

Problem-05

Calculate the future value of a sum of Rs.5000 if it is invested for 2 years with
an interest compounding Semi-annually, Quarterly and Monthly at 12%.
Solution:-
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Asst. Professor, Department of Management

ii) Future Value of even cash flow

FVn = PV (1+r) n-1 + PV (1+r) n-2+ PV (1+r) n-3+ PV (1+r) n-4 ………+ PV

Or

FVA = PCF (1+r) n – 1

r

Problem-06

Mr. Ajay deposits Rs. 6,000 at the end of each year for 5 years in his saving account. Paying
9% interest compounded annually. He wants to determine how much sum of money he will
have at the end of 5th year.
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Asst. Professor, Department of Management

Problem-07

Compute the Future value for the following payments made over a period of 5 years at 12%
rate of interest.

Year 1 2 3 4 5
Payments 3000 3000 3000 3000 3000
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Asst. Professor, Department of Management

PROBLEM-08

Mr. Sushanth deposits Rs.12, 000 at the end of each year for 6 years and deposits earns
compound interest at 12% p.a. Determine how much sum of money he will have at the end of
6 years.
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Asst. Professor, Department of Management

iii) Future Value of Uneven cash flow

FVUECF = R1 (1+r) n-1 + R2 (1+r) n-2+ R3 (1+r) n-3+ R4 (1+r) n-4 ……

Where,
FVUECF = Future value of Uneven cash flow
R1, R2 ,R3 = Uneven cash flow
r = rate of Interest
n = No. of years

PROBLEM-09

Calculate the Future value at the end of 5 year of the following series of payment at 9% rate
of interest, Rs.2000 at the end of 1st year, Rs.4000 at the end of 2nd year, Rs.6000 at the end
of 3rd year, Rs.8000 at the end of 4th year, Rs.10000 at the end of 5th year.
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Asst. Professor, Department of Management

PROBLEM-10

Calculate the Future value of the following cash flow if it is invested at 8%

interest p.a.

At the end of Amount Deposited

the year
1 1000
2 2000
3 3000
4 4000
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Asst. Professor, Department of Management

iv) Future value of Annuity

PROBLEM-11

Mr. Naveen deposited Rs.1000 annually in a bank for 5 years at 10% interest
compounded. Calculate future value at the end of 5 years.

PROBLEM-12

Mr. Anand deposited Rs.5000 annually in a bank for 5 years at 10% interest
compounded. Calculate future value at the end of 4 years.
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Asst. Professor, Department of Management

B. DISCOUNTING TECHNIQUES.

i) Present value of Single cash flow

PV = __FV____
(1+r) n
Where,
PV = Present value
FV = Future Value
r = Rate of Interest / Discounting rate
n = No. of years

PROBLEM-13

Mr. Mohan receive Rs.30, 000 after 5 years from now his time preference for
money is 10% p.a. Find Present value.

PROBLEM-14

Calculate the present value of sum of Rs.25, 000 received after 2 years if the
discount rate is 8% p.a.
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Asst. Professor, Department of Management

PROBLEM-15

Calculate present value of Rs.5000 received at the end of a year if the discount
rate is 9% p.a.

ii) Present Value of even cash flow

PV = F____ + F____ + F____ + F____ + - - - - - - - - + F____

(1+r) 1 (1+r) 2 (1+r) 3
(1+r) 4
(1+r) n

Where,
F = Future cash flow

PV = Present Value

r = Rate of Interest / Discounting rate

n = No. of years
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Asst. Professor, Department of Management

PROBLEM-16

Find out the present value of Annuity receipt of Rs.8, 000 received for 5 years
at the rate of 8% discount.

PROBLEM-17

What is the present value of Annuity of Rs.9, 000 received at the end of 5th year.
If it is invested at 10%.
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Asst. Professor, Department of Management

iii) Present Value of Uneven cash flow

PV = F____ + F____ + F____ + F____ + - - - - - - - - + F____

(1+r) 1 (1+r) 2 (1+r) 3
(1+r) 4
(1+r) n

Where,
F = Future cash flow
PV = Present Value
r = Rate of Interest / Discounting rate
n = No. of years

PROBLEM-18

Calculate the Present value of the following series of payments made at the end
of each year for the period of 5 years at 8% interest rate.

Rs. 8, 000 at the end of 1st year

Rs.10, 000 at the end of 2nd year
Rs.12, 000 at the end of 3rd year
Rs.14, 000 at the end of 4th year
Rs.16, 000 at the end of 5th year
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Asst. Professor, Department of Management

PROBLEM-19

Compute the present value of cash inflows using formula method as well as
table method.

Year 1 2 3 4 5
Expected cash Flow 1000 2000 3000 4000 5000
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Asst. Professor, Department of Management

iv) Present value of Annuity

PROBLEM-20

Mr. Arun receives Rs. 1000 dividend annually for 3 years. Calculate present
value of this stream of dividend at a discount of 10%?
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Asst. Professor, Department of Management

PROBLEM-21

Mr. Darshan receives Rs. 3000 dividend annually for 3 years. Calculate present
value at a discount of 10%?
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Asst. Professor, Department of Management

DOUBLING PERIOD

It refers to the method in which a particular sum of money is double in a

definite period of time at a specified rate of interest.

This is calculated by using the formula:-

1. Rule 72 = Doubling Period = 72

Rate of Interest

2. Rule 69 = Doubling Period = 0.35 + 69

Rate of Interest

PROBLEM-22

Calculate the doubling period for a sum of Rs.8, 000 at 6% rate of Interest per
anum.

PROBLEM-23

Calculate the doubling period if an investor invests his deposit at 12% interest
by using rule 69 and 72.
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Asst. Professor, Department of Management

VALUATION

Valuation is the process of estimating the worth of something having economic

or monetary value. It is usually expressed as a price/ earnings ratio.

CONCEPT OF VALUATION:

1. Book Value
2. Market Value
3. Liquidation Value
4. Replacement Value
5. Going concern Value

A. VALUATION OF BOND/ DEBENTURE:

1. Redeemable Bond/ Debenture

PV of Bond = I1____ + I2____ + I3____ + M3____

1
(1+r) (1+r) 2 (1+r) 3
(1+r) 3

Where,
PVB = Present Value of Bond

I = Interest amount received

r = Discounting rate/ Capitalization rate

M = Maturity value

PROBLEM-24

A Bond is available for Rs.1000. It has interest amount of Rs.80 per year for a

period of 5 years with the capitalization rate of 12%. The bond has the maturity

value of Rs.1140. Advice the investor in his

hi buying decision.
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Asst. Professor, Department of Management
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Asst. Professor, Department of Management

PROBLEM-25

A Debenture is available in the market for Rs.1000 with Rs.80 as interest for a

year for a period of 4 years with the maturity value of Rs.1120. The debentures

capitalization rate is 10%. Advice [Link] in his buying decision of this

debenture.
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Asst. Professor, Department of Management

2. Irredeemable Bond/ Debenture

PV of Bond = I____
r

Where,
PVB = Present Value of Bond
I = Interest amount received
r = Discounting rate/ Capitalization rate

PROBLEM-26

What is the value of Irredeemable debentures which as Rs.60 as the interest for
infinite period with the discount rate at 9%.

PROBLEM-27

How much an investor has to pay for the following debt instrument whose
interest per year is Rs.70. Its capitalization rate is 11%.
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Asst. Professor, Department of Management

B. VALUATION OF PREFERENCE SHARE:

1. Redeemable Preference share

PV of Preference share = D1____ + D2____ + D3____ + M3____

1
(1+r) (1+r) 2 (1+r) 3
(1+r) 3
Where,
PVPS = Present Value Redeemable Preference share
D = Dividend of the year
r = Discounting rate/ Capitalization rate
M = Maturity value

PROBLEM-28

How much an investor has to pay for the redeemable preference shares which
has dividend of Rs.70 per year for next 4 year with maturity value of Rs.1150.
The capitalization rate is 8%.
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Asst. Professor, Department of Management

PROBLEM-29

A preference share is available in the stock market with the following

information:

a. Maturity value of preference share Rs.1120.

b. Dividend amount of Rs.50 per year.

c. Maturity period is 4 years.

d. Discount rate is 8%.

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Asst. Professor, Department of Management

2. Irredeemable Preference share

PVIPS = D____
r
Where,
PVIPS = Present Value Irredeemable Preference share
D = Dividend of the year
r = Discounting rate/ Capitalization rate

PROBLEM-30

A company issued 8% irredeemable preference share of Rs.100 each. The

capitalization rate is 6%. Compute present value of preference shares.

PROBLEM-31

Compute the present value of 7% Irredeemable preference shares of Rs.100

each. If the capitalization rate is 11%.
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Asst. Professor, Department of Management

C. VALUATION OF EQUITY SHARE:

1. Dividend Capitalization Model

a. Single Period Valuation Model

PVES = D1____ + P1____

1
(1+r) (1+r) 1

Where,
PVES = Present Value Equity share
D1 = Dividend paid in the 1st year
P1 = Sale price of equity share at the end of the year
r = Discounting rate/ Capitalization rate

PROBLEM-32

Mr. Raghu holds an equity share which has the features of getting Rs.20 as
dividend for the First year. He aspects to sell the same share for Rs.190 at the
end of the year. What is the value today if the capitalization rate is 11%.
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Asst. Professor, Department of Management

PROBLEM-33

Mr. Anand is planning to buy an equity share hold it for 1 year and then sells it.
The expected dividend at the end of the year is Rs.8 and expected rates is
Rs.220 at the final year.

Determine the value of equity share if the capitalization rate is 14%.

b. Two period Valuation Model

PVES = D1____ + D2____ + P1____

1
(1+r) (1+r) 2 (1+r) 2

Where,
PVES = Present Value Equity share
D1 & D2 = Dividend paid in the 1st & 2nd year
P1 = Sale price of equity share at the end of 2nd year
r = Discounting rate/ Capitalization rate
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Asst. Professor, Department of Management

PROBLEM-34

Mr. Raj is holding the equity share of a company which has the following
features.
The dividend of 1st and 2nd year is Rs.8 and Rs.10.
The discount rate is 9%.
The sale price of equity share at the end of 2nd year is Rs.160.
Calculate the present value of equity share.
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Asst. Professor, Department of Management

PROBLEM-35

Mr. Ashok is planning to buy an equity share hold it for two years then sale it.
The expected dividend at the end of 1st year and 2nd year is Rs.10 and Rs.12.
expected selling price of share at the end of 2nd year is Rs.280. Discount rate is
16%.
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Asst. Professor, Department of Management

c. When dividend rate is constant

PVES = D1____
r

Where,
PVES = Present Value Equity share
D1 = Dividend
r = Discounting rate/ Capitalization rate
PROBLEM-36

XYZ Co., ltd currently paying a dividend of Rs.30 per share. It is expected that
the company will pay the same dividend in the future. The current capitalization
rate is 16%. What is the present value of equity share.

PROBLEM-37

Calculate the present value of equity share. If the dividend is Rs.20 per share for
an infinite period with the capitalization rate is 16%.
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Asst. Professor, Department of Management

d. When the dividend is growing at constant rate

PVES = D1____
r -g

Where,
PVES = Present Value Equity share
D1 = Dividend
r = Discounting rate/ Capitalization rate
g = Growth rate

PROBLEM-38

A Company is expected to pay dividend of Rs.8 per share by next year. The
dividends are expected to grow continuously at the rate of 10%. What is the
value of equity share, if the required rate of return is 12%.

PROBLEM-39

An investor is planning to purchase a equity share which has the following

features:

The current dividend is Rs.30. The discount rate is 16%. The growth rate is 8%.
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Asst. Professor, Department of Management

e. When the dividend rate is growing at variable rate

Procedure:
Step 1: Calculate the present value of Dividend
Step 2: Find out the present value of equity share at the end of year with constant growth in dividend.
Step 3: Find out present value of equity share today

PROBLEM-40

A Company is expected to pay a dividend of Rs.5 per share. After a year its
dividends are expected to grow 14% for next 5 years and then at the rate of 7%
indefinitely. Find out the PVES if the capitalization rate is 11%.
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Asst. Professor, Department of Management
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Asst. Professor, Department of Management

PROBLEM-41

A Company is currently paying a dividend of Rs.4 per share. The dividend is

expected to grow at 16% for next 5 years and at 11% forever. What is the
present value of the share? If the capitalization rate is 14%.
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Asst. Professor, Department of Management
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Asst. Professor, Department of Management

2. Earning Capitalization Model

PVES = E____
r

Where,
PVES = Present Value Equity share
E = Earning per share
r = Discounting rate/ Capitalization rate

PROBLEM-42

Calculate the present value of equity share of a company which earns

Rs.1, 00,000 which is to be distributed among 10,000 shareholders with the
capitalization rate is 12%.

PROBLEM-43

Calculate the price of equity share according to earning capitalization model.

When earning per share is Rs.22 with the capitalization rate is 13%.

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