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THE TIME VALUE OF MONEY

 A Rupee received today is worth more than a Rupee

received tomorrow
This is because a Rupee received today can be invested

to earn interest The amount of interest earned depends on the rate of return that can be earned on the investment
Time value of money quantifies the value of a Rupee

through time

 Time Value of Money, or TVM, is a concept that is

used in all aspects of finance including:

Bond valuation Stock valuation Accept/reject decisions for project management Financial analysis of firms And many others!

 There are many types of TVM calculations We are Covering basic types

Present value of a lump sum Future value of a lump sum Present value of cash flow streams Future value of cash flow streams

 Common formulas that are used in TVM calculations:* Present value of a lump sum:

PV = PV = FVt / (1+r)t
Future value of a lump sum:

FVt = FVt = PV * (1+r)t

Variables

r = rate of return t = time period n = number of time periods PV = present value FV = future value
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 Present value calculations determine what the value

of a cash flow received in the future would be worth today (time 0) The process of finding a present value is called discounting (hint: it gets smaller) The interest rate used to discount cash flows is generally called the discount rate

 1.

How much would Rs.100 received five years from now be worth today if the current interest rate is 10%? Draw a timeline

?
0 1

i = 10%

Rs.100

The arrow represents the flow of money and the numbers under the timeline represent the time period.
Note that time period zero is today.
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2.

Write out the formula using symbols: PV = FVt / (1+r)t FV = Rs. 100 n=5 i = 10% PV = ?

3.

Insert the appropriate numbers: PV = 100 / (1 + 0.1)5

4.

Solve the formula: PV = Rs. 62.09

 You can think of future value as the opposite of present

value Future value determines the amount that a sum of money invested today will grow to in a given period of time The process of finding a future value is called compounding (hint: it gets larger)

 1.

How much money will you have in 5 years if you invest Rs.100 today at a 10% rate of return? Draw a timeline

Rs.100 0 1 2

i = 10%

?
4 5

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2.

Write out the formula using symbols: FVt = PV0 * (1+r)t i = 10% n=5 PV = Rs.100 FV = ? Substitute the numbers into the formula: FV = Rs.100 * (1+0.1)5 Solve for the future value: FV = Rs.161.05
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3.

4.

 In both of the examples, note that if you were to

perform the opposite operation on the answers (i.e., find the future value of Rs.62.09 or the present value of Rs.161.05) you will end up with your original investment ofRs.100. This illustrates how present value and future value concepts are intertwined. In fact, they are the same equation . . .
Take PV = FVt / (1+r)t and solve for FVt. You will get FVt = PV *

(1+r)t.

As you get more comfortable with the formulas and

calculations, you may be able to do the calculations on your calculator alone. Be sure you understand WHAT you are entering into each register and WHY.
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 A cash flow stream is a finite set of payments that an

investor will receive or invest over time.

The PV of the cash flow stream is equal to the sum of the

present value of each of the individual cash flows in the stream.

The PV of a cash flow stream can also be found by taking

the FV of the cash flow stream and discounting the lump sum at the appropriate discount rate for the appropriate number of periods.

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Joe made an investment that will pay Rs.100 the first year,Rs.300 the second year,Rs.500 the third year andRs.1000 the fourth year. If the interest rate is ten percent, what is the present value of this cash flow stream?

Write out the formula using symbols:

n t=0

PV = S [FVt / (1+r)t]

OR PV = [FV1/(1+r)1]+[FV2/(1+r)2]+[FV3/(1+r)3]+[FV4/(1+r)4] Substitute the appropriate numbers: PV = [100/(1+.1)1]+[Rs.300/(1+.1)2]+[500/(1+.1)3]+[1000/(1.1)4]

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Solve for the present value:

PV = Rs.90.91 + Rs.247.93 + Rs.375.66 + Rs.683.01 PV = Rs.1397.51 Check using a calculator:

Make sure to use the appropriate rate of return, number of periods, and future value for each of the calculations. To illustrate, for the first cash flow, you should enter FV=100, n=1, i=10, PMT=0, PV=?. Note that you will have to do four separate calculations.

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 The future value of a cash flow stream is equal to the sum

of the future values of the individual cash flows.

The FV of a cash flow stream can also be found by taking

the PV of that same stream and finding the FV of that lump sum using the appropriate rate of return for the appropriate number of periods.

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Assume Joe has the same cash flow stream from his investment but wants to know what it will be worth at the end of the fourth year Write out the formula using symbols
n

t=0

FV = S [CFt * (1+r)n-t]

OR FV = [CF1*(1+r)n-1]+[CF2*(1+r)n-2]+[CF3*(1+r)n-3]+[CF4*(1+r)n-4] Substitute the appropriate numbers: FV = [$100*(1+.1)4-1]+[$300*(1+.1)4-2]+[$500*(1+.1)4-3] +[$1000*(1+.1)44]

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Solve for the Future Value: FV = $133.10 + $363.00 + $550.00 + $1000 FV = $2046.10 Check using the calculator: Make sure to use the appropriate interest rate, time period and present value for each of the four cash flows. To illustrate, for the first cash flow, you should enter PV=100, n=3, i=10, PMT=0, FV=?. Note that you will have to do four separate calculations.

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THANK YOU.

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