The Time Value of Money - Future and present value

Learning outcomes
What is the time value of money
Time line
Future and present value of lump sum
Future and present value of annuity
Perpetuity
Uneven cash flow stream
Compounding periods
Amortized loan
Abstract
One of the most predominant concept to amassing wealth and turning out to be financilally
independent is understanding the time value of money.The vast majority are amarzed when
they genuinely comprehend the influence of compounding and how incredible the time value
of money can be. Also, one of the most pressing issues facing financial managers is how to
determine the present value of future cash flows.Basically this chapter covers future and
present value of lump sum and annuity,perpetuity,uneven cashflow,amortized loan.

01.What is the time value of money ? (TVM)
Time value of money is the concept that money that’s present at this time is worth
more than the equivalent amount within the future,because of its potential earning
capacity.
02.Time line
Physical illustration of the amounts and timing of cash flows associated with an
investment project.[ CITATION Tim \l 1033 ]
CF0 – Today
CF1 – End of the first period and the beginning of the second period
Illustration
Draw a time line for investment of Rs.80000 today that returns Rs.40000 in the first
year,nothing in the second year and Rs.50000 in the third year.
03.Simple interest and compound interest
Simple interest- Earn only on the principle amount
Compund interest - Interest is earn on both the principle and accumulated interest of
prior period
Simple interest = PRT
P = Principle amount
R = Interest rate
T = No.of years
[ CITATION Nic \l 1033 ]
0 1 2 3
CF0 CF1 CF2 CF3
0 1 2 3
(80000) 40000 0 50000
Compount interest = P(1+r)n – P
P = Principle amount
r = annual interest rate
n = No. of years interest is
applied

04.Power of time and interest rate
Future value of the original investment increases with the time
An increase in interest rate leads to an increase in future value
05.Future value and present of lump sum
Lump sum is a one time payment or repayment of funds at a particular point in time
06.Future and present value of annuities
Annuity – even cash flows occurring at even intervals
Two type of annuity
Ordinary annuity – series of regular payments made at the end of each period
Annuity due – series of regular payments made at the beginning of each period
06.01.Ordinary annuity
1
(1+r)n
FV = PV(1+r)n
FV = Future value
PV = Present value
r = annual interest rate
n = No. of years interest is applied
PV = FV *
FV = Future value
PV = Present value
r = annual interest rate
n = No. of years interest is applied
1 - (1+ r)-n
r
(1+ r)n – 1
r
PV = A*
FV = Future value
PV = Present value
r = annual interest rate
n = No. of years interest is applied
FV = A*
FV = Future value
PV = Present value
r = annual interest rate
n = No. of years interest is applied