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Time Value of Money

According to the time Value of the Money DECREASE but No. of Money INCREASE. Annuity is the term used to describe a series of periodic flows of equal amounts. Under the method of compounding, we find the Future Values (FV) of all the cash flows at the end of the time horizon at a particular rate of interest. Under the method of discounting, we reckon the time value of money now i.e., at time zero on the time line. So, we will be comparing the initial outflow with the sum of the present values (PV) of the future inflows at a given rate of interest. There are 2 cases for calculation:

Lump sum The FIXED amount deposited in ONE time. Lump sum PV = A PVIF Where:

Installments The EQUALLY amount deposited or withdrawn in same period. effective rate of interest can be calculated by the following formulae:-

A = Future Amount. Installment (Annuity) PV = A PVIFA Where:

FV = A FVIF Where:

A = Present Amount.

Here: k=rate of return , n = maturity. Rules & some more formulas: 1) If rate of interest is given in less than 1year (compounding period is semi annually or quarterly) than

FV = A FVIFA Where:

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S = Smallest value ( m = compounding period. K= Nominal Rate of Interest. Where: A = Amount (Effective rate of interest is always greater then nominal rate of interest) 2) If installment given in monthly than k = after using the above formulae: If rate of interest is annually to monthly than: K = (1+k)1/12 1 If rate of interest is monthly to annually than: K= (1+k)12 1 K= Effective rate of Int. 3) If compounding period is monthly than effective rate of interest: = k / 12 4) If the word (beginning) given in question than formulae multiplied by: (1 + k) 5) If k is not given in question than: K= Where: L1 = Lower rate L2 = Higher rate H = Highest value B = Base value Please visit for more info: www.financialpath.in The Pacific Institute of Financial Studies & Research n= Rule of 72: n= = 8) Sinking fund factor: = 9) Rules of Doubling period: Rules of 69 : 7) Capital recovery factor: K = Nominal rate of return ) 6) Present value of Perpetuity (Infinite terms) = A/K

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Some Numerical Questions Based on Above Formulas

Q1. Mr.Sharma plans to save Rs.20,00,000 for his daughters education and marriage in fifteen years. The State Bank of India pays 8% interest compounded annually. If Mr.Sharma is planning to make equal annual contributions at the end of every year for a period of fifteen years, how much should he put in the bank annually? (a) Rs. 73,333.30 (b) Rs. 73,659.40 (c) Rs.1,66,666.70 (d) Rs.1,76,243.00 (e) Rs.2,38,596.50. Q2. Suppose you plan to buy a Santro costing Rs.4,50,000 and go for a motor vehicle loan being offered by the ICICI bank. The rules of the bank require you to make a down payment of Rs.45,000. The remaining amount would be financed by them and the repayment can be done over five years. The interest rate offered by the bank is 12% compounded monthly. If you accept this proposal, the equated monthly payment and the effective annual interest rate respectively are (a) Rs. 6,750; 12.12% (b) Rs. 8,760; 12.68% (c) Rs. 9,008; 12.68% (d) Rs.10,008; 12.88% (e) Rs.10,567; 12.98%. Q3. Mr. Ali takes a loan of Rs.1,00,000 from Fortune Finance Company Pvt. Ltd. As per the loan agreement, Mr. Ali has to pay off the loan in thirty-six monthly installments of Rs.5,000 each. The effective annual rate of interest that the finance company is charging Mr. Ali is (a) 36.20% (b) 43.44% (c) 53.22% (d) 60.20% (e) 64.45%. Q4. Excel Computers Ltd, is planning to accumulate Rs.10,00,000 in a sinking fund account to repay a debenture liability at the end of five years from now. The rate of interest paid by banks on their deposits is 8% per annum. How much should the company deposit in its sinking fund account every year? (a) Rs.1,45,566.67 (b) Rs.1,70,444.86 (c) Rs.2,00,000.00 (d) Rs.2,30,555.67 (e) Rs.2,70,444.86. Please visit for more info: www.financialpath.in The Pacific Institute of Financial Studies & Research

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Q5. The fixed deposit scheme of Akshara Finance Corporation offers 12% p.a. interest for a three-year deposit. If the interest is compounded semi-annually, then the maturity value of a deposit of Rs.50,000 is approximately (a) Rs.59,559 (b) Rs.70,246 (c) Rs.70,926 (d) Rs.75,246 (e) Rs.82,936 .Q6. Novelty Industries is establishing a sinking fund to redeem Rs.5 crore bond issue, which matures in 15 years. How much do they have to put into the fund at the end of each year to accumulate the Rs.5 crore, assuming the funds will earn a return of 7% compounded half yearly? (a) Rs.17.76 lakh (b) Rs.18.88 lakh (c) Rs.19.71 lakh (d) Rs.20.09 lakh (e) Rs.21.13 lakh. Q7. Hyderabad Grameena Bank (HGB) has various deposit schemes which offer the same effective rate of interest of 8 percent per annum compounded quarterly. Mr.Charan plans to save Rs.150 at the beginning of every month with HGB in a monthly recurring deposit scheme which has a maturity period of three years. What is the maturity value at the end of three years? (a) Rs.4,556 (b) Rs.5,224 (c) Rs.6,116 (d) Rs.6,656 (e) Rs.7,005. Q8. Mr.Kumar borrowed an amount of Rs.5,50,000 from Margadarsi Finance Ltd. As per the loan agreement, he has to repay Rs.3 lakh at the end of 7th year, Rs.4 lakh at the end of 8th year, Rs.2lakh at the end of 9th year and Rs.2 lakh at the end of 10th year from now. In order to meet these payments, he wants to deposit money in a bank scheme at the end of every year for six years that offers an interest rate of 11% p.a. Thereafter he plans to retain the money in the bank account and withdraw required amounts as and when warranted. The interest rate is expected to remain 11% from 7th to 10th year. The approximate amount that Mr. Kumar should invest at the end of every year for a period of 6years is (a) Rs.1,02,090 (b) Rs.1,10,312 (c) Rs.1,21,293 (d) Rs.1,28,905 (e) Rs.1,89,389. Please visit for more info: www.financialpath.in

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Q9. Mr. Sarathi deposits Rs.500 at the beginning of every quarter in the recurring deposit scheme of Majeera Bank for six years. If the bank offers an interest rate of 12 percent per annum compounded quarterly, the amount accumulated by the end of six years is (Round off your answer to the nearest integer) (a) Rs.15,546 (b) Rs.17,729 (c) Rs.18,765 (d) Rs.19,254 (e) Rs.20,187. Q10. Mr.Aravind wants to invest in a pension fund according to which ten years from now he will start receiving a pension of Rs.2,000 every month. The payment will continue for 10 years. How much is the pension worth today if the interest rate is 11.50% compounded quarterly? (Round off your answer to the nearest integer) (a) Rs.25,238 (b) Rs.29,237 (c) Rs.34,568 (d) Rs.39,876 (e) Rs.45,997. Q11. Mr. Kiran borrows Rs.1,00,000 at 8% compounded annually. Equal annual payments are to be made for six years. However, at the time of the fourth payment, the individual decides to pay off the entire loan. How much amount should Mr. Kiran pay at the end of the fourth year approximately? (a) Rs.45,609 (b) Rs.50,207 (c) Rs.56,578 (d) Rs.60,208 (e) Rs.65,428. Q12. Bhagyanagar Finance Company Ltd. is offering a pension scheme for people who have just completed 40 years. According to the scheme the individuals who subscribe will have to deposit Rs.25,000 per year for 20 years. At the end of 20 years, every subscriber will receive a specific sum plus an annuity of Rs.1,00,000 for a period of 25 years. If the depositors wish to earn 11% rate of return, the specific amount to be paid by Bhagyanagar Finance Company Ltd. at the end of 20 years apart from the annuities is (a) Rs. 1,18,007 (b) Rs. 7,62,875 Please visit for more info: www.financialpath.in

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(c) Rs. 5,31,650 (d) Rs. 9,39,433 (e) Rs.12,94,695. Q13. Mr.Pavan Kumar borrowed an amount of Rs.1,00,000 from a bank to be repaid in five equal annual installments. If the rate of interest is 14% p.a. on the reducing balances, the amount of principal amortized in the second installment is (a) Rs.12,040 (b) Rs.14,122 (c) Rs.17,249 (d) Rs.23,131 (e) Rs.29,128 Q14. Mr.Chalapati plans to buy a house for a price of Rs.25 lakh. Good People Bank offers 80% of the purchase price of the house as loan repayable in 10 years by equal quarterly installment of Rs.1,20,000. His friend agrees to provide the balance amount on condition that a lump sum amount of Rs.6 lakhs to be repaid to him after 1 year. What is the effective cost of borrowings to Mr.Chalapati under the above plan? (a) 15.35% (b) 17.42% (c) 20.24% (d) 22.43% (e) 25.00% Q15. Mrs. Reddy is 60 years old and she is expecting that she will live for another twelve years. Her total savings are Rs.2,00,000, which she has deposited in a bank. She wants to spend her savings equally over these twelve years. If the interest earned on the deposit is 10% per annum, the withdrawal made at the end of every year from her deposit over the defined period is (a) Rs.19,458.363 (b) Rs.20,119.063 (c) Rs.25,258.363 (d) Rs.29,352.663 (e) Rs.39,352.063. Q16. You are required to contribute Rs.2,000 per year in a pension plan for 10 years from the end of the current year. The plan will pay pension annually for a period of 20 years and the first payment will start after 16 years from now. If this plan is arranged through a savings bank that pays interest @ 7% per annum on the deposited funds, what is the size of the yearly pension? (a) Rs.2,578 Please visit for more info: www.financialpath.in

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(b) Rs.2,945 (c) Rs.3,456 (d) Rs.3,570 (e) Rs.3,659. Q17. Mr.Albert Rozario plans to purchase a flat in Goa after 2 years, whose present cost is Rs.10 lakhs. The cost of the flat is expected to increase by 15 % every year. Union Bank of India has agreed to finance upto 75% of the cost of flat whenever he buys the flat. He has recently deposited Rs.1 lakh with the bank at an interest rate of 10% p.a quarterly compounded which will become due for payment after 2 years. How much amount has Mr. Albert save every month to deposit under the cumulative deposit scheme of the bank so that the required amount of margin for the loan would be available after 2 years ? (Corrected to hundred) (a) Rs. 7,900 (b) Rs. 8,200 (c) Rs. 9,600 (d) Rs.10,400 (e) Rs.12,000 Q18. Ms.Aruna borrowed an amount of Rs.50,000 from a bank to be repaid in five equal annual installments. If the rate of interest is 12% p.a. on the reducing balances, the amount of principal amortized in the second installment is (a) Rs. 6,000 (b) Rs. 7,870 (c) Rs. 8,814 (d) Rs.13,870 (e) Rs.20,000. Q19. Everymans Bank pays interest at 10 percent p.a. compounded semi-annually. Janata Bank compounds interest on monthly basis. If Janata Bank wishes to pay the same effective rate of interest as that of Every mans Bank, the nominal rate of interest it should quote is (a) 9.80% (b) 10.00% (c) 10.25% (d) 10.75% (e) 11.00% Q20. The IDBI deep discount bond offers investors Rs.2,00,000 after 25 years, for an initial investment of Rs.5,500. The implied interest rate on the bond, approximately is (a) 12.5% Please visit for more info: www.financialpath.in

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(b) 13.5% (c) 14.5% (d) 15.5% (e) 16.5%. Q21. Chancellor Mills Ltd., availed a term loan of Rs.4 crore from Union Bank of India to finance their new project. As per the terms and conditions of the loan, the repayment will start after two years and the loan together with interest is to be liquidated in 10 equated half yearly installments. The loan will bear an interest rate of 13% p.a with quarterly compounding. The amount of each installment is (a) Rs.70,30,965 (b) Rs.72,20,256 (c) Rs.73,20,764 (d) Rs.75,36,913 (e) Rs.80,16,435 Q22. Mr. Srinivasan has against the pledge of jewellery borrowed Rs.10,000 from a local money lender . The said loan is to be paid back in 12 equated monthly installments of Rs.1,000 each commencing after one month. The effective interest paid by Srinivasan on the loan is (a) 15.2% (b) 20.6% (c) 36.5% (d) 41.3% (e) 52.6%. Q23. As per the rule of 69, if the amount deposited today doubles in four years and seven months, the effective interest rate per annum is (a) 15.1 percent (b) 15.5 percent (c) 15.8 percent (d) 16.0 percent (e) 16.3 percent

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Answers of the Question

1. Answer: b Reason: In order to accumulate Rs, 20,00,000, after 15 years, Mr Sharma has to deposit A amount of rupees every year. Therefore, 20,00,000 = A * FVIFA(8% , 15yrs) A= 2. Answer: c Reason: Amount of loan = Rs 4,50,000 45,000 = Rs 4,05,000. Interest rate per month = 12%/12 = 1% Let the monthly payment be A. Therefore, 4,05,000 = A * PVIFA (1%, 60) A=

Effective annual rate = (

3. Answer :C Reason:- Pv = Rs 1,00,000 N = 36months Payment = Rs 5000 1,00,000 = 5000 PVIFA(r%, 36) Solving for r ( by interpolation method) For r = 3%, RHS = Rs 1,09,161.26 For r = 4%, RHS = Rs 94,541.41 By interpolation: R= Effective rate of interest = ( 1 + 0.0362 )12 1 = 53.22%. 4. Answer B Reason : FV = Annuity amount FVIFA (r%, 8) Annuity amount = Therefore, the company has to deposit Rs. 1,70,444.86 in the sinking fund account.

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5. Answer C Reason: Effective interest rate = (

Maturity value of the deposit is: = A FVIF 50,000 (1.1236)3 = Rs.70,926. 6. Answer : (c) Reason: First find out the effective annual rate (EAR) EAR = re = (1 + r/m)m 1 Where, r = nominal rate of interest, i.e., 7% m = number of times compounding done (Semi Annually) = 2 re = (

Now, let the sinking fund payment be A. Rs, 5,00,000 = A FVIFA(7.123%,15) A= Therefore Rs.19.71 lakh has to be paid into the sinking fund at the end of each year. 7. Answer (c) Reason: Effective annually rate of interest : Effective rate of Int. = (1+0.08/4)4 - 1 = (1.02)4 = .0824 or 8.24% Effective monthly rate of interest = = .6623% This is a case of annuity due because the cash flows are occurring at the beginning of every month. Hence maturity value = Rs.150FVIFA(r%,n)(1+r) = Rs.150FVIFA(0.6623%,36) (1+0.006623) = 15040.5041.006623 = Rs.6,115.84 = Rs.6,116(approx) 8. Answer b Reason: At the end of 6years, the future value of the amount that Mr.Kumar deposits each year for a period of 6 years, should be equal to the present value of the payments that he has to make under the loan agreement in the 7th, 8th, 9th, and 10th years. The discounted value of the payments to be made at the end of 7th, 8th, 9th & 10th years, as at the end of 6th year = 3PVIF(11%, 1)+ 4PVIF(11%, 2)+ 2PVIF(11%, 3)+2PVIF(11%, 4)= 8.729 lakh. Please visit for more info: www.financialpath.in

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Let X be the amount to be invested at the end of every period till 6 years Future value of the deposits made at the end of every year, for a period of 6 years = X. FVIFA(11%,6years) X. FVIFA(11%,6years) = Rs. 8.729 lakh X= Hence Mr. Kumar has to deposit Rs.1,10,312 at the end of every period for 6 years so as to be able to make the payments made under the loan agreement. 9. Answer (b) Reason: Quarterly rate of interest is 12% 4 = 3.0 percent Tenure of the scheme = 6 years 4 = 24 quarters. The maturity value of this recurring deposit plan will be = Rs.500FVIFA(3%,24) (1+0.03) = 500 x 34.426 x 1.03 = Rs.17,729.39 (approximately). 10. Answer (e) Reason: First we need to find the annual interest rate. It is given that the interest rate is compounded quarterly, therefore the effective annual rate (EAR) of interest is found out as follows: EAR = re = (1 + r/m)m 1 Monthly rate of return = = 0.0095 100 = 0.95% Total number of months = 120 The value of the pension annuity today can be found out in two steps. The present value of the annuity in the 9th year as the payment starts in the tenth year. i.e., Annuity value x PVIFA(0.95%, 120) = 2,000 x 71.53 = Rs.1,43,050 The present value of the figure obtained Rs.1,43,050 x PVIF(0.95%,120) = 1,43,050 x 0.322 = Rs.45,997 11. Answer d Reason: the equated annual payment (EAP) which is computed comprises of both the interest and the principle amount. In this case, we need to first compute the EMI and then compute the break up of interest and principle amount. This will give us the amount of principle to be repaid at the end of each year. Thus while making the fourth payment, the EMI plus the principle amount remaining has to be paid. 1,00,000 = EAP PVIFA(8%,6yrs) EAP = 1,00,000 PVIFA(8%,6yrs) = Rs.21,630.98 Now let us see the break up of the EAP. Year Principle (1) Interest Principle Principle component(2)= component(3) remaining(4) (1)0.08 = EAP (2) = (1) (3) 1 1,00,000 8,000.00 13,630.98 86,369.02 Please visit for more info: www.financialpath.in

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2 3 4 5 6 86,369.02 71,647.56 55,748.38 38,577.27 20,032.47 6,909.52 5,731.80 4,459.87 3,086.18 1,602.60 14,721.46 15,899.18 17,171.11 18,544.80 20028.38* 71,647.56 55,748.38 38,577.27 20,032.47* -

*Actually these figures should be the same. But due to rounding off there is a minor deviation. Now the amount to be paid at the end of fourth year: = EMI + the principle amount remaining at the end of fourth year. = Rs.21,630.98 + Rs.38,577.27 = Rs.60,208.25 12. Answer (b) According to the given information subscribers will deposit Rs.25,000 for 20 years and after 20 years scheme will pay Rs.1,00,000 at the end of every year for 25 years plus Rs. x at the end of 20 years from now. The discount rate is 11%. Therefore the data can be fit into an equation as 25,000 FVIFA(11%,20yrs) = X + 1,00,000 x PVIFA(11%,25yrs) 25,000 64.203 = X + 1,00,000 x 8.422 16,05,075 = X + 8,42,200 X= 16,05,075 8,42,000 = Rs.7,62,875 13. Answer (c) Reason: Let the equal annual installment be A. 1,00,000 = A x PVIFA(14%,5yrs) Therefore A = 1,00,000 PVIFA(14%,5yrs) = Rs.29,131 Every installment comprises an interest component and a principal component. The interest component in the first installment = 0.14 1,00,000 = Rs.14,000. Hence the amount of principal amortized by the first installment = 29,131 14,000 = Rs.15,131 Interest component of the second installment = (1,00,000 - 15,131) .14 = Rs.11,882 14. Answer (d) Cost of the house = Rs.25,00,000 and the amount of loan = Rs.25,00,000 .8 = Rs.20,00,000 Amount borrowed from his friend = Rs.5,00,000 Amount to be repaid to the friend after 1 year = Rs.6,00,000 Monthly installment to bank = Rs.1,20,000 Hence, 25,00,000 = 120,000 PVIFA(k%,40) + 6,00,000 PVIF(k%,4) RHS, K at 5%, = 1,20,00017.1591 + 6,00,0000.8227 = 20,59,092 + 4,93,620 =Rs.25,52,712 K at 6% ,RHS = 1,20,000 x 15.0463 + 6,00,0000.7921 = 18,05,556 + 4,75,260 = Rs.22,80,816 Please visit for more info: www.financialpath.in

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By interpolation; Effective annual interest rate = (1+ 0.0519)4 1 = 22.43% 15. Answer (d) Equated annual withdrawal PVIFA(10%,12yrs) = Rs.2,00,000 Equated annual withdrawal 6.8137 = 2,00,000 Equated annual withdrawal = 2,00,000 6.8137 = Rs29,352.663 16. Answer (e) E Future value of the 10-payments annuity = 2000FVIFA(7%,10yrs) = 200013.816 = Rs.27632. The amount of Rs.27632 is available immediately after the last payment. The future value of this at the end of the 15th year FV = 27632 FVIF(7%,5yrs) = 27632 1.403 = Rs.38768 The annuity amount of the retirement annuity = Rs.38768 APVIFA(7%,20yrs) =38768 A= 38768 10.594 =Rs.3659 17. Answer (a) Effective interest rate = ( Effective interest rate is =(

) )

Effective monthly rate = (1 + 0.1038)1/12 = 0.826% Expected cost of the flat after 2 years = 10 (1 + 0.15)2 = Rs.13,22,500 Bank loan = 13,22,5000.75 = Rs.9,91,875 Margin required = 13,22,500 9,91,875 = Rs.3,30,625 The maturity amount of two year fixed deposit = 1,00,000FVIF(10%,2yrs)= Rs.1,21,840 The amount to be received under cumulative deposit = 3,30,625 1,21,840 = Rs.2,08,785. The monthly amount to be saved : 2,08,785 = APVIFA(.826%,24) = Rs.7901.33. 18. Answer (c) Let the equal annual installment be A. 50,000 = A x PVIFA(12%,5) Therefore A = = Rs.13,870 Every installment comprises an interest component and a principal component. The interest component in the first installment = 0.1250,000 = Rs.6,000. Hence the amount of principal amortized by the first installment = 13,870 6,000 = Rs.7,870 Interest component of the second installment = (50,000- 7,870).12 = Rs.5,056 The amount of principal amortized in the second installment Please visit for more info: www.financialpath.in

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=13,870 5,056 = Rs.8,814. 19. Answer (a) Effective rate of interest of Everyman Bank = 10.25% Nominal rate of interest of Janata Bank = 9.80 20. Answer (d) The future value of a single cash flow is given as FV = PV(1+ k)n 2,00,000 = 5,500(1+ k)25 By interpolation RHS K= 15% LHS K= 16% k = 15.45% or 15.50%. 21. Answer (b) Effective Annual rate = 13.65% The loan amount after the moratorium period = 4,00,00,000 = Rs.5,16,63,106. Effective half-yearly rate = (1 + 0.1365)1/2-1 = 6.6% 5,16,63,106 = Rs.72,20,256 22 Answer (d) PV = A PVIFA(k%,12yrs) 10,000 = 1000 PVIFA(k%,12yrs) Let K be At 2% ; Rs.10,575.3 At 3%; Rs.9962 By interpolation; Effective rate per annum = (1 + 0.02925) 12 -1 = 41.33% 23. Answer (e) According to the rule of 69, Doubling period (in years) = 0.35 + 4.(712) = 0.35 + (69k) Solving the above equation we get k = 16.3%.

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