Sinking Fund is created to pay a liability. Eg.redemption of a debenture. Sinking Fund is the reciprocal of Annuity.

A=

Fn

i (1+i)n - 1

Sinking Fund Formula using Table Method SF = A = fn [ 1/cvfa ni]

Class work A company has issued debentures of Rs. 50 lakhs to be repaid after 7 years. How much should a company invest in a sinking fund, earning 12% in order to pay debentures.

Solution A = 50,00,000 .12 (1+.12)7 -1

= 4,95,584/-

Present Value
Present value:

The current worth of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at a discount rate.

Formula Pv = Fn pv = Fn 1 (1+i)n PVF

i n

Class Work 1. What is the Present Value of a FD that will pay Rs.1000 in 3 years if the prevailing interest rate is 5% compounded annually? How much do I need to deposit now.

Solution
pv = Fn PVF

i n

= 1000 (.864 ) = 864

Present Value of an Annuity Formula PV of an annuity = Annuity i Pv of an annuity table method Pv = A *(pvfa n i)

1 -

1 (1+i)n

Class Work What amount you must invest today at 6% compounded annually so that you can withdraw Rs.5000 at the end of each year for the next 5 years.

solution
Present Value of an Annuity Solution PV of an annuity = 5000
.06 =

1 -

1 (1+.06)5

Rs. 21,058

Class Work
Present value of uneven cash Flows Consider that an investor has an opportunity of receiving Rs.1000, Rs.1,500, Rs.800,Rs.1100 and Rs. 400 respectively at the end of one through five years. Find the present value of the stream of uneven cash flows . The required rate of return is 8%

Solution
No of Years 1 2 3 4 5 Total Amount 1000 1500 800 1100 400 Present Value .926 .857 .794 .735 .681 Total Value 926 1286 635 809 272 3928

Present value of a growing annuity

In this case each cash flow grows by a factor of (1+g). Similar to the formula for an annuity, the present value of a growing annuity (PVGA) uses the same variables with the addition of g as the rate of growth of the annuity (A is the annuity payment in the first period)

Present value of a growing annuity

1+g

p=
i-g

11+i

Pv of a growing annuity

Problem A company pays a dividend of Rs.66/- . The dividend stream is expected to grow at 10% per annum for 15 years. If the discount rate is 21 %, what is the present value of the expected series?

Present value of a growing annuity

66

1.10 1.21

15

p= 1.21 -.10 = Rs. 456.36/-

Perpetuity
The present value of a fund which is segregated for perpetuity is calculated by dividing the amount with the interest rate. Class work: An asset is expected to fetch Rs.1000 for perpetuity @ 10% interest. what is the present value of the asset or what compensation would an investor accept today instead of having it for perpetuity.

Present value of a perpetuity Present value = = Perpetuity Interest rate 1000 .1 = Rs.10.000/-

Loan Amortization.
Loan Amortization is the method used to calculate the equated monthly instalments. A = p 1 i 1 1 i(1+i)n

Loan Amortization using Table method Installment Amount = P 1 PVFA

ni

Class Work
Amortize a 6% loan of Rs.25,000 paid back in 4 annual end of the period installments.

Solution: = 25000 1 3.465

= 7215

Loan Amortization repayment schedule.

Year Beg. Amt
1 2 3 4 25000 19285 13227 6806

Annual Interest instalment

7214 7214 7214 7214 1500 1157 793 408

Principal repayment
5714 6057 6421 6806.40

Remaining balance
19285 13227 6806 0

Present Value of an Annuity Due: = Present value of an Annuity (1+i)

Broken period calculations

Problem Exactly 10 years from now Mr. Nitin will start receiving a pension of Rs.3,000 a year. The payment will continue for 16 years. How much is the pension worth now. If Nitins interest rate is 10%

Solution

Years 1 25 years Years 1 9 = no pension Total pv of an annuity for 25 years @ 10% = 9.077 Total pv of an annuity for first 9 years @ 10% = 5.759 Present value of the pension = 3000 (9.077 5.759) = 9954

Implicit interest rate or rate of return

Problem A bank has offered to you an annuity of Rs.1,800 for 10 years if you invest Rs.12,000 today. What rate of return would you earn/

Implicit interest rate or rate of return

Solution: 12,000 = 1800 (pvfa r,
10)

pvfa r, 10 = 12000/1800 pvfa r, 10 = 6.667 Refer table for present value factor of an annuity of Re.1 equal to 6.667 @ 8% = 6.710 @ 9% = 6.418 So it lies between 8 and 9 %

Using method of linear interpolation

8% +

lower discount Value Required value

Higher discount value lower discount value

= 8.15%

6.710 - 6.667 6.418 - 6.710 =.15

Double the amount

Problem How long will it take to double your money if it grows at 12 % annually? Solution: Fn = p * cvf ni 2 = 1 * cvf n 12 From the table of compoud value factor the factor nearest to 2 @ 12% is 1.974 therefore n = 6 years