TIME VALUE OF MONEY

POOJA GUPTA

APNA SAPNA MONEY MONEY

RUPEE IN HAND IS BETTER THAN TWO IN THE FUTURE MONEY IN BANK GIVES MORE RETURN THAN IN SAFE INFLATION-TRUE MEANING

SIMPLE & COMPOUND INTEREST

SIMPLE INTEREST IS SIMPLE COMPOUND INTEREST IS COMPOUND..

COMPARISON
SIMPLE INTEREST COMPOUND INTEREST

Rs. 1000 becomes total amount after: 1Yr -1100 10 Yr -2000 50 Yr -6000 100 Yr -11000

Rs. 1000 becomes total amount after: 1Yr -1100 10 Yr -2594 50 Yr -117390 100 Yr -13780612

TERMINOLOGY
Present Value (PV) of an amount that will be received in the future Future Value (FV) of an amount invested now at a given rate of interest Present Value of a Annuity (PVA) is the present value of a stream of (equally-sized) future payments Present Value of a Perpetuity is the value of a regular stream of payments that lasts "forever", or at least indefinitely Future Value of a Annuity (FVA) is the future value of a stream of payments (annuity)

PRESENT VALUE OF A FUTURE SUM

1. 2. 3. PV is the value at time=0 FV is the value at time=n i is the rate at which the amount will be compounded each period n is the number of periods

4.

APPLICATION
You expect to receive Rs.10,000 6 years from now. The current market interest rate is 10%. How much investment will you make today? Rs. 565

FUTURE VALUE OF PRESENT SUM

The future value (FV) formula is similar and uses the same variables. 1. PV is the value at time=0 2. FV is the value at time=n 3. i is the rate at which the amount will be compounded each period 4. n is the number of periods

APPLICATION
You have received Rs. 20,000 from your grandparents. You invest the money in bank fixed deposit which pays 9% annual interest. The fixed deposit is for 5 years. How much money will you receive at the time of maturity? Rs. 30,780

PRESENT VALUE OF ANNUITY

1. PVA the value of the annuity at time=0 2. A the value of the individual payments in each compounding period 3. i equals the interest rate that would be compounded for each period of time 4. n is the number of payment periods.

APPLICATION
You want to buy a car. At present auto loan rate is 12% per annum. You can comfortably pay monthly installment of Rs.10,000 for the next 5 years. How much can you borrow right now? Rs. 4,32,600

PRESENT VALUE OF GROWING ANNUITY

1. 2. PVA the value of the annuity at time=0 A the value of the individual payments in each compounding period i equals the interest rate that would be compounded for each period of time n is the number of payment periods. g is growth rate of annuity

3.

4. 5.

APPLICATION
You are looking to buy a property for investment purpose. The current rental (annual) at the kind of properties you are looking at is Rs. 1,80,000. The growth rate in rental is 8% p.a. The discount rate is 10% p.a. What is the kind of investment you will be looking at taking 5 years as time period? Rs. 82,11,305

PRESENT VALUE OF ANNUITY

1. PVA the value of the annuity at time=0 2. A the value of the individual payments in each compounding period 3. i equals the interest rate that would be compounded for each period of time

APPLICATION
Valuation of equity shares What should be the present value of a share which pays a dividend of Rs.20 per share. It is expected the company will keep paying the same amount as dividend forever. The discount rate is 12%. Rs.166.67

FUTURE VALUE OF ANNUITY

1. 2. FV(A), the value of the annuity at time = n A, the value of the individual payments in each compounding period i, the interest rate that would be compounded for each period of time n, the number of payment periods

3.

4.

APPLICATION
You have a PPF account in which you can deposit Rs.60,000 per year (max. investment). At 11% interest rate and 15 year maturity; how much money will you have at maturity ? Rs.20,64,300 And for minimum investment of Rs.500? Rs. 17,203

EFFECTIVE VS. STATED RATE OF INTEREST

I is the stated annual interest rate N is the frequency of compounding each year R is the effective interest rate

EFFECTIVE VS. STATED RATE OF INTEREST

What is the effective interest rate, given annual interest rate as 12% being compounded: Annually Semi annually Quarterly Monthly Daily

VALUATION OF BONDS
Bond valuation is the process of determining the fair price of a bond The fair value of a bond is the present value of the stream of cash flows it is expected to generate The price or value of a bond is determined by discounting the bond's expected cash flows to the present using the appropriate discount rate

Bond Valuation Contd..

Cash flows:
the periodic coupon payments C, each of which is made once every period; the par or face value F, which is payable at maturity of the bond after T periods.(NB final year payment will include the

par value plus the coupon payment for the year)

Discount rate: the required

(annually compounded) yield or rate of return r.
r is the market interest rate for new bond issues with similar risk ratings

EQUITY VALUATION
The Dividend Discount Model (DDM) is the basis of understanding other methods of valuation. Lets begin with the simplest model: the Steady Growth Model. This is best used for large companies with predictable dividend growth.
Price = D/(r-g)

D = Current Dividend r = Discount Rate (the companys WACC) g = Dividend Growth Rate

EQUITY VALUATION
There is also a Multi-Stage Growth Model. This is used for companies that are expected to experience fast growth in their dividend at first followed by slower, more predictable growth as the company matures. There is no standard, plug-and-chug equation for this model. However, it still uses the same form as the Steady Growth Model.

EQUITY VALUATION
Heres an example:

Here, the company is assumed to have dividend growth of 20% for next 5 yrs., 10% for next 2 yrs., and 7% thereafter, with the current dividend being 1.24, and a discount rate of 13.66%