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# FINANCIAL MANAGEMENT

MBA (FM/HR/IT)
III- Trimester

INTRODUCTION

## In projects companies invest a sum of money in anticipation

of benefits spread over a period of time in the future

## If we borrow `100 today @ 10% (i.e. 09-Aug-10) from SBI

than we will have to pay `110 (08-Aug-11), the additional
`10 is called interest or time value of money

## Decision can be made by two methods:

Compounding method
Discounting method

## FUTURE VALUE OF A SINGLE CASH

FLOW
It is the process of determining the future value
of a lump sum amount invested at one point of
time.
We calculate the future value of a single cash flow
compounded annually by

FV = PV(1+i) n
FV= Future value
PV = initial cash flow
i = interest rate per annum
n = the number of compounding periods

EXAMPLE

## Suppose ` 1100 are placed in the saving

account of a bank at 5% pa. how much shall
it grow after 2 years if interest is
compounded annually

## If compounding is done for shorter compounding

period, then:
FV = PV (1+ ) m x n
i
m

## FV= Future value

PV = initial cash flow
i = interest per annum
m = number of times compounding is done in a year
n = the number of compounding periods

EXAMPLE

## Suppose Vijaya Bank gives 10% pa interest

and interest is compounded quarterly then
calculate the return after two years if Harsh
deposit ` 1000 today in Vijaya Bank

SOLUTION
FV = PV (1+ mi ) m x n
= 1000(1+0.10/4) 4 x 2
= 1000(1+0.025) 8
= 1000 x 1.2184
= ` 1,218

FV= ?
PV= 1000
m= 4
n= 2

FLOWS

## Instead of investing lump sum at one time if money is invested in

multiple flows then how value of money will be affected?

## Suppose Mr Paw Invests ` 1,000 now (at the beginning of one

year), ` 2,000 at the beginning of year 2 and ` 3,000 at the
beginning of year 3, how much these flows accumulate to at the
end of year 3 at a rate of 12% pa?

SOLUTION
FV3 = ` 1000 x FVIF(12,3) + ` 2000 x FVIF(12,2) + ` 3000 x FVIF(12,1)

=`[(1000x1.405)+(2000x1.254)+(3000x1.120)]
= ` 7273

## Annuity is the term used to describe a series of periodic

flows of equal amounts.
The example of payment of Life insurance premium (` 2000
per annum) for next 20 years can be classified as an
annuity.
The future value of a regular annuity for a period of n
years at a rate of interest
i is given by the formula:
n

(1 i ) 1)
FVA A[
]
i

FVA AxCVFA(i ,n )

## A= Amount deposited at the end of

every year
i= Interest rate
n= Time Horizon
FVA= Accumulation at the end of
n year

EXAMPLE

## Suppose Mr Jain deposits ` 2000 at the end of

every year for 10 years at the interest rate of
10% per annum, then how much will be his
corpus after 20 years?

SOLUTION

(1 i ) 1)
FVA A[
] AxCVFA(i ,n )
i
n

(1 0.10) 1)
FVA 2000[
]
0.10
10

= 2000x 15.94
= ` 31880

SINKING FUND

## It is used when we want to calculate how much

we have to deposit every year for X years at the
interest rate of i% pa to receive amount Y at the
end of X year.

We know that
FVA=A x CVFA(i,n)
A= FVA x 1/CVFA(i,n)

EXAMPLE

## Suppose we want to accumulate ` 500,000 at the end of 10

years. How much should we deposit each year at an interest
rate of 10% per annum so that it grows to ` 500,000.

SOLUTION

## With this approach, we can determine the present value of a

future cash flow or a stream of future cash flows

projects.

## Suppose if we invest `1000 today at 10% pa for a period of 5

years, we know that we will get ` 1000 x FVIF(10,5)
=`1000x1.611 =`1,611 at the end of 5 years

## FV= PV x FVIF(i,n) ; PV =FV/FVIF(i,n) PV=

PV = FV x PVIF(i,n)

FV
(1 i )

## The present value of an annuity A receivable at

the end of every year for a period of n years at a
rate of interest i is equal to:

(1 i ) 1
PVA A[
]
i (1 i )
n

PVA= A x PVIFA(i,n)

EXAMPLE

## Suppose Mrs Ravina deposits ` 1000 every year

for 8 years with 15% interest rate per annum,
then what is the present value of her deposits?

SOLUTION
A = ` 1000
n= 8 years
i= 12%
PVA=?
PVA= A x PVIFA(i,n)
PVA = 1000 x PVIFA(12,8)
PVA = 1000 x 4.968
PVA = 4968

AMORTIZATION

## If HDFC housing finance gives home loan to a person

then they will decide the EMIs through this method.
P= A x PVFA(i,n)

1
A= P

PVAF
n ,i

A = P CRFn,i

## Suppose Mr X takes a loan of ` 50,000 today to buy a

motor-cycle for his son. If interest rate is 10%, how
much Mr X will have to pay per year to repay his loan
in 3 equal end of year repayments? [`20104.543]

## It tells that how much shall we invest today so that we can

get equal amount every year for indefinite time

## For example If Hari expects ` 5,000 from his investments

then how much he will have to invest today, if rate of
interest is 10% per annum
Present Value = 5000/0.10 = ` 50,000

## When annuity is calculated from the beginning of

the year it is called annuity due
In the case of annuity due or when payment is
made at the beginning of the year, which means
last payment has completed one year at the time
of calculation

## Suppose that you deposit ` 1000 in saving account at

the beginning of each year for 5 years to earn 4%
interest rate

## Future value of an annuity due= future value of an

annuity x (1+i)

(1 i ) n 1)
FVA A[
](1 i )
i
= A x CVFA(I,n) x (1+i)
= 1000 x 5.416 x 1.04
= ` 5632.64

## Suppose you deposit ` 500 at the beginning of each

year for 5 years at 10% interest rate. Calculate the
present value of annuity.
Present Value of Annuity due = present value of
annuity x (1+i)

(1 i ) 1
PVA A[
]
i (1 i )
n

= ` 2085.05

## Net Present Value (NPV) of a financial decision is

the difference between the present value of cash
inflows and the present values of cash outflows.

## NPV = PV of Cash Inflows PV of Cash Outflows

If NPV is negative, it means investment in
project higher than the return. So, project will be
rejected.

EXAMPLE

## Reliance industries is planning to start a project which

requires ` 1000 Cr at the beginning year and ` 200 Cr
at the beginning of second year. They are expecting to
get a return of ` 250 Cr at the end each year for next
5 years. Suggest whether reliance should go for the
project or not, If interest rate in the market is 10% per
annum.

SOLUTION
Year

PV Factor

Present

1/(1.10)T

Value (Cr)

`250

0.909

`227.25

T=2

`250

0.826

`206.5

T=3

`250

0.751

`187.75

T=4

`250

0.683

`170.75

T=5

`250

0.621

`155.25

T=0

`1000

T=1

`200

PV Factor

Present

1/(1.10)T

Value (Cr)

`1000

0.909

`181.8

Total

= - ` 234.3 Cr

`1181.8

Inflow

`947.5