Skip to main content

What is Time Value of Money? How does it calculate ?


Time Value of Money: It is a concept that the value of money in our hand is more valuable today than the value we will receive in future. It is basically shows the effect of time on money value .For example if you lend Rs. 200, 000 to someone and the borrower has given two option to you that 1st he can pay you today , 2nd he will pay you after 5 years. In that case you prefer 1st option because there is no risk of default in payment of money and you can earn interest on that value if you invested somewhere and also there is no loss of purchasing power. With the help of time value of money we can take some decisions like investment, loan or lease. We can analyse which future investment option is best for today.

 Present Value: The current worth of future sum of money. It is also called present discounted value, higher the discounted values lower the present value.

Future Value: The value of money received at a specified date in future which is equivalent to the value of money receives today.

Interest: It is also called discount interest rate or growth rate. When future value is calculated interest is compounded which is known as growth rate and when present value is calculated interest is discounted which is known as discounted interest rate.

N: it denotes number of periods in future value or present value formula. The value of “n” will not be equal to the number of periods when interest is compounded monthly, quarterly and half yearly. For example Rs. 5000 invested for 2 years @ 5.6% interest compounded monthly. Then in that case n=2*12=24. Similarly in case of compounded quarterly and half yearly.

Formula to calculate future value:

  •  FVIF: With the help of Future Value Interest Factor (FVIF) table in which interest (i) and number of periods (n) are given. We can easily calculate future value.
  •  Mathematical Formulas: Through formulas we can calculate future value and present value. And the formula is:

                              FV=PV (1+i) n
Where,
PV= present value
FV= future value
i= interest rate
n= number of year

Formula to calculate Present Value:
  • PVIF: We can calculate present value with help of present value interest factor (PVIF) table in which number of periods and interest are given.  
  • Mathematical Formulas: we can use mathematical formulas to calculate present value and the formula is:

                           PV=FV/ (1+i) n

Formula to calculate number of periods (n):

           N = In (FV/PV)/In (1+i)

Formula to calculate interest rate (i):
          I = (FV/PV) 1/t -1

Example 1: If someone invested Rs. 10, 000 for 4 years with simple annual interest of 7% .Find out the future value?

Solution:
FV=PV (1+ (i *n))
=10, 000(1+ (0.07 * 4))
=10,000(1+ 0.28)
=10, 000 * 1.28
=12800

 Example 2: Ravi invested Rs.98000 @ 6% compounded quarterly for 5 years then how much amount he would get after 5 years?

Solution:
FV=PV (1+i) n
=98000(1+0.015) 20
=131991.79

Example 3: What is the present value of Rs.2, 30,000 to be received at the end of 3 years , assuming an interest rate of 8.4% compounded annually?

Solution:
PV=FV / (1+i) n
=230000/ (1+0.084) 3
=180567.76

Example 4: How long does it take for Rs. 5, 00,000 to grow into Rs.9, 25,000 @ 7.5% compounded half yearly?

Solution:
N =In (FV/PV)/In (1+i)
=In (925000/500000)/In (1+0.0375)
=In (1.85) /In (1.0375)
= 0.6151/0.0368
= 16.7
= 8 years

Example 5: What interest rate is implied if you borrow Rs. 4, 00,000 and repaid Rs.6, 50,000 in 4 years?

 Solution:
FV=PV (1+r) n
I= (FV/PV) 1/t-1
= (650000/400000) 1/4-1
=12.9%





Comments

Post a Comment

Popular posts from this blog

How to calculate Cost of Preference Share Capital?

Cost of Preference Share Capital:  An amount paid by company as dividend to preference shareholder is known as Cost of Preference Share Capital. Preference share is a small unit of a company’s capital which bears fixed rate of dividend and holder of it gets dividend when company earn profit. Dividend payable is not a tax deductible amount. So, there is no tax adjustments required for comparing with cost of debt. Formula for Cost of Preference Share: Irredeemable Preference Share Redeemable Preference Share K p  = Dp/NP K p  = D p +((RV-NP)/n )/ (RV+NP)/2 Where, K p  = Cost of Preference Share D p  = Dividend on preference share NP = Net proceeds from issue of preference share (Issue price – Flotation cost) RV = Redemption Value N = Period of preference share Example:  A company issues 20,000 irredeemable preference share at 8% whose face value is Rs.50 each at 4% discount. Find out the Cost of ...
88 comments
Read more

What is the difference between Cheque book and Pass book?

 Cheque book is issued by bank in customers / account holder request. With the help of this book account holder can withdraw cash from his/her account. Bank does not charge any fee to issued cheque book to its customer. But afterward bank charges some amount for using bank facility like cheque book, Debit card etc.So, Automatic some definite amount deducted from customer bank account. Pass book is  also issued by bank to its customer. It helps to record all the bank related activity according to date that is withdrawal and deposit. It is recorded by bank but the book is kept by customer to know the current balance of  his /her account.  Point of difference Pass book Cheque book What is the meaning of pass book and cheque book? Passbook is a book in which all withdrawal and deposit against customer account is recorded.   Cheque book is a book of cheques which are used to withdrawal the money to b...
Post a Comment
Read more

Numericals with solutions of Net income Approach

Net income approach questions and answers:   Questions:  Find out the value of the firm with the help of given information: Particulars Amount Earnings before interest and tax 3, 50, 000 Cost of equity 10% Cost of debt 7.2% Debenture 1,00,000 Find out the overall cost of capital with the help of net income approach. (Assume tax rate-10%) Solution: Particulars Amount Earnings before interest and tax 3, 50, 000 Less: Interest @7.2% 7, 200 Earnings before tax 3, 42, 800 Less: Tax@10% 34, 280 Net income 3, 08, 520 Cost of equity 10% Market value of equity (S =net income/ cost of equity) 30, 85, 200 Market value of debt (B) 1, 00, 000 Value of the firm (S+B) 31, 85, 200 Questions:  Find out the overall cost of capital if the equity capitalisation rate is 12...
Post a Comment
Read more