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CORPORATE FINANCE
(Module-1)
By
Prof. B.P. Kar
1. INTRODUCTION TO CORPORATE FINANCE:
 Finance is the life blood of business.
 In general sense it is the provision of money when it is required.
 Its management is concerned with the process of acquiring financial resources and its judicious usage,
so as to maximize the firms value, thereby maximizing owners and shareholders wealth.
 The responsibility of Finance manager is to acquire funds needed by the firm, by diversifying the
sources on one hand and its immediate effective utilization on the other.
 Thus the success and failure of any firm is predominantly linked with the quality of financial decision.
 The Globalization era in recent days practice has cause to bring some tremendous reform in financial
management.
 The infusion of information technology for coupled the interest of financial authority to add the
innovation to their existing ideas to diversify the sources and way to utilize the funds.
 Hence, it results to cause the increment in competition, merger, takeover, cost management, quality
improvement of financial discipline.
 Again in the light of global competition its a question of survival before many an industry, in the to the
spectrum of global economy.
 But the age of information technology has given a fresh perspective to the financial manager, by
changing the paradigm from controller to facilitator.

CLASSIFICATION OF FINANCE

FINANCE

PUBLIC FINANCE PRIVATE FINANCE

Govt. Institution
Personal Finance

State Govt.
Business Finance

Central Govt.
Finance of Non-
profit Organisation
Local self Govt.

BUSINESS FINANCE

Sole proprietor Finance Partnership firms finance Company or corporation finance

Sole Proprietorship Firms Finance:

 In this type of Finance, the entire finance has made upon a single person, who is the proprietor.
 The financial risks also attached with the concerned person.
Partnership Firm Finance:
 Its an also association of more than one person, where each partners are recognized co-owners.
 The partners are collectively burdened the risk of business.(Financial risk and other risk).
Corporation Finance:
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 It is the creation of law.

 It has the legal entity with perpetual succession and common seal

 It is treated as something different from the owner.

 The assets are lies with the corporation and liabilities are born by it.
 The internal resources is the process of infusion and diffusion against some consideration.
 Presently, the business activities are carried on by company form of organization, which needs to be
analyzed, while attaining with the financial activities.
 So, segregation of business finance firm corporation finance is a subject of in-conduciveness, rather
both is mutually inclusive.

APPROACHES TO CORPORATE FINANCE OR FINANCIAL PROCESS

Financial process / approach are of two types:
(i) TRADITIONAL APPROACH (ii) MODERN APPROACH.
FINANCIAL PROCESS:
The F.M. process begins with financial planning and decision. In the course of its implementation, it has to bear
some risk and discharge certain return. These risk and return determines the NAV of firm, and its overall
financial worthiness. It also includes some feed-back system for taking corrective measures if required.
Traditional approach:
 It was developed. between 1920-1930.
 It was confined only to procurement of funds from different sources.
 There was no mention of the ways to utilize the funds effectively.

The finance, manager was performing the following functions under this approach.

 Arrangements of short-term and long term funds from Financial institution..

 Mobilization of funds through various financial instruments like:- Equity shares, preference shares,
debentures, bonds etc.
 Bridging the gap between finance functions and accounting functions.
 Making the legal compliance of procuring funds from different sources.
DEMERITS:
It was a short-run phenomenon as it suffers from some serious lacunas such as:-
 It ignores the internal aspects of business, like-utilization of funds and allocation of funds.
 It lacks attention to-wards working capital arrangements and it is focused only to procure long term
funds.
 Overlooking day to day financial problem.
In light of the above lacunas the expert in finance were developed another approach by modernizing the
existing one called modern approach.

This includes the followings:

 Total funds requirement of the firm.
 The assets to be acquired.
 The pattern of financing the assets.
 By the application of Financial Engineering such as:- Mathematical programming, Simulation
approach, etc. the aspects of fund raising, allocation of funds, and proper control over finance are
made an easy jobs.
 This approach also consider three basic management decision making process. Such as:-
 Investment decision.
 Finance decision.
 Dividend decision
INVESTMENT DECISION:
 It includes determination of the way to utilize scarce resources effectively.
 Effective in the way, every investment of capital nature needs supportive investment of revenue nature.
 Capital investment means, investment to acquire fixed asset of external investment.

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 Revenue investment means, investment in current assets or working capital investment or internal
investment.
 Thus to be having with an effective investment, horizon, effort should be made to make the above type
of investments, inter-related with suitable properties.
Investment decision covers the followings:-
 Ascertainment of total volume of funds.
 Selection and security of capital investment.
 Measurement of risk and un-certainty in investment proposal.
 Prioritization of investments.
 Allocation of funds and its rationing.
 Determination of proportion of investment in fixed assets and current assets.
 Buy or lease decision.
 Replacement or renovation decision.
 Asset management and portfolios management decision.

FINANCING DECISION:
 It aims to ascertain proper mixture of different source of finance such as- Debt & equity.
 It is subject to change as per market condition.
 The outcome is to lowering the out-going interest from the in-coming yield out of genuine investment
decision, there- by giving some net yield.
 Another aspect is to manage the immediate working capital needs by some short term financing.
 Moreover, on part of the finance manager, finance decision involves :-cost of funds, debt-equity mix,
advantage and disadvantage of debt component in capital mix, impact on taxation and depreciation,
maximizing EPS,Cost and Financial control.
 Elaborately it involves the following:
(i) Determination of financing pattern.
(ii) Segregating long term Finance from short and medium term finance.
(iii) Making suitable pattern for each term of financing.
(iv) Utilizing various financial instruments at the right time.
(v) Arranging institutional Finance for different terms of Financing.
(vi) Considering cost of capital.
(vii) Considering possible changes in debt.-equity ratio and its impact in firm’s liquidity.
(viii) Taking possible tax advantage by using different source of finance.
(ix) Optimizing finance mix to improve EPS & making wealth maximization.
(x) Portfolio management.
(xi) Avoiding over & under capitalization by taking necessary action
(xii) Considering foreign exchange risk by strict vigilance on international development.
(xiii) Study the impact of stock market on firm’s wealth.
(xiv) Evaluation of alternative use of funds.
(xv) Considering budget setting and performance evaluation.

DIVIDEND DECISION:

 It deals with the quantum of profit to be distributed among shareholders and the frequency of payment.
 It has two impact:
 The amount to be paid and its impact on share price.
 The amount of retained earnings for internal purpose.
 The regular growth of dividend determines firm’s credibility in the capital market, which helps to
maximize the wealth of firm to a great extent.
 The finance manager will consider the followings in the matter of dividend.
 Determining a balance between dividend payment and retained earning.
 Considering the impact of the above on N.A.V. of the firm.
 Considering retention of more money for expansion and diversification, by issuing
bonus share.
 Re-considering the above balance in boom and recession.
 Considering the legality aspect in dividend payment decision.

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SCOPE OF CORPORATE FINANCE:

The followings are the scope on part of a finance manager to manage the financial composure and complexity
of an organization:
 Estimating financial requirements.
 Deciding capital structure.
 Selecting a source of finance.
 Selecting a pattern of investment
 Proper cash management.
 Implementing financial control
 Use of surpluses.
ESTIMATING FINANCIAL REQUIREMENT:-
 This is the first task of a finance manager.
 He/ She should prepare in financial plan both on period base and term base.
 Segregating total requirements of long-term(Fixed asset-purpose) and short term (working capital
purpose).
 Proper estimation should be made to avoid liquidity and idle fund situation.

DECIDING CAPITAL STRUCTURE:

 It is the proportion of different financial instruments and sources.
 The proportion should be fixed by taking market trend, Cost of capital, Gestation period.
 Basically long-term finance should be used for fixed asset purpose, and short term finance for working
capital purpose.
 We can use long term funds for working capital if situation demand by not depending upon bank O.D.
of cash credit.

SELECTING A SOURCE OF FINANCE:-

 It is the aftermath of preparing capital structure.
 There are various sources to raise finance such as:- Share capital, Debentures, Financial institutions and
banks and public deposit.
 For short term finance F.Is, Banks and public deposits are appropriate.
 For long term finance share capital and debentures are useful.
SELECTING A PATTERN OF INVESTMENT:
After procuring the funds, the needs are how to utilize it in a best possible ways to get in high rate of return.
There are two ways to invest:-
(1) Invest in fixed asset
(2) Invest in current asset(working capital)
 Before investing in fixed asset, the profitability criterion should be considered by applying the formula
of N.P.V., IRR, ARR, and opportunity cost.
 This is instrumental in decision making process of investments. Similarly before investing and
acquiring of assets the aspects like- Quality, Productivity, Lasting and Competitiveness are considered.
 In fine a balance line should be created between risk and return before making an investment decision.
PROPER CASH MANAGEMENT:
 It’s an important function for finance manager.
 The finance manager has to assess the cash requirements first and then arranging the same from
necessary sources.
 Cash is needed for working capital purpose like:-
 Maintaining inventory status.
 Payment to creditors.
 Meeting day to day maintenance.
 Payment of wages.
 Cash management means avoiding idle cash and scarcity of cash.
 Cash flow statement is instrumental in proper cash management.
Timely utilization of source is possible only when its timely availability is made. That paves the
way to a better cash management situation.

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 All avoiding expenses should not be borne by cash rather it should be avoided.
IMPLEMENTING FINANCIAL CONTROL:-
 This is a yardstick to have a better financial management.
 It involves several devices like:-
 R.O.I.
 Budgetary control
 Break-even analysis
 Ratio analysis
 Cost audit and internal audit.
 These techniques have some great help for finance manager in performance evaluation and corrective
action.
PROPER USE OF SURPLUSES:-
 This also an important function of financial manager.
 An efficient use of this paves the way for expansion and diversification of business.
 It also has an impact on N.A.V., as N.A.V. also having a positive trend by better dividend declaration.
 A judicious policy of utilizing surplus is always guided by the following factors.
 Trend of earning.
 Expected earning in future
 Market value of shares.
 Funds required for expansion and diversification.
 An efficient finance manager will always get-rid of all these factors.

OBJECTIVES OF CORPORATE FINANCE:

 The main concern of financial management is procurement of funds and its subsequent effective
utilization.
 The aim here is to maximize firms value/earning for which different alternative ways are needed.
 Each alternatives has to be evaluated to find out the best one.
 For better accomplishment of objective, a division of objectives are made on the following basis.
 Profit maximization
 Wealth maximization
PROFIT MAXIMIZATION:
 Profit is the survival stone of every business, which paves the way for growth and development
 It also a measure of efficiency and protection against risk.
Profit and profit maximization:
 When there is profit, its maximization is obvious.
 Profitability is the bridge between profit and profit maximization. Because in this condition even
though the profit amount is same, but it is at maximum due to cost reduction. So, it is an indication of
better efficiency.
 Profit is a fluctuating word. It cannot kept always. But profit maximization has an immense help during
the recessionary period for survival.
 Growth and profits are interdependent. If profit maximization is their, speed and high growth will be
the immediate outcomes.
 Profit alone cannot fulfill the C.S.R., rather it needs profitability.
CRITICISM
 It is materialistic in nature, which leads to exploitation of workers, corruption& immorality.
 It makes the organization ethically bankrupt.
 It has no clear-cut definition.
 It ignores time value of money.
 It ignores risk factors.
 Lack of willingness to pay dividend.

WEALTH MAXIMIZATION:
 It is the appropriate objective of an enterprise.
 It means maximizing positive net present value by a course of action.
 It is a decision-making process and possible through long term planning and management control.

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 Profit maximization is the past, but wealth maximization is the converted goal, after ownerships are
separated from management and increasing volume of competition.
 Wealth maximization means, maximizing payment of dividend and capital gain to share holder.
 To materialize this the management has to maximize the positive yield or return.
 The wealth maximization objectives also consider the time consumed and risk attached to the positive
yield or return.

WEALTH MAXIMIZATION AND FAVORABLE CONDITIONS.

 It takes long term survival and goals into consideration.
 It aims at stabilizing owners improved resources and enhanced payment to stakeholders.
 Decision making processes are focused to appreciate the N.A.V.
 It recognizes risk and time value of money.
 It considers P.V. concept, E.P.S. and dividend payment.
 It is partially influenced by profit maximization.
 It is a share-holders centric approach, because they always emphasized on appreciation of N.A.V.

S.T. FUND L.T. FUND

W.C. F.A.

Cash inflows from operation

Debt. Payment Dividend
Retained earning

Operational Cash in flows

Debt. Obligation Retained earning

Dividend payment
financing

Firms wealth maximization

CRITICISM:
 It is far from ground reality and confined to theory.
 It is not socially desirable.
 There is a controversy regarding maximizing wealth of either stakeholder or others claimants.
 It has a wide scope of conflict in managerial interest and stakeholder’s interest in the light of wealth
maximization.

In spite of all these, the objective should be achieved to resist in the present days context of
competitions and technology.

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OBJECTIVES OF CORPORATE FINANCE IN CO-TEMPORARY BUSINESS ENVIRONMENT.

 During this era of globalization with free flow of money, materials resources and technology and
objective of financial management is a matter of wide spread phenomenon.

OPERATIONAL OBJECTIVES:
Maximizing sales:
 This objectives aims to serve the best interest of the firm, since it is the principal source of revenue.
 Maximizing growth:
 Growth maximization in the light of globalization have acquired phenomenal interest.
 It gives hiked salary, prestige and status and more over job security to employees.

Maximizing R.O.I. It is the yardsticks of efficiency.

 To prove yourself as better investor, you have to be cautions and believe on appropriate time-cost-risk
relationships.
 It paves the way to go for expansion, modernization and diversification of firm which brings and better
stability to the organization.
SOCIAL OBJECTIVES:
 To identify the volume of net social contribution of firm.
 From this net social contribution what will be born from internal sources and what is there from
external sources.
 To determine whether the mission of the firm will be at par with the overall social system or any
deviation there-to.

GROUP OBJECTIVES:
Production goals:
 Ensuring output level not below the bottom line, but effort should be made to up grade the existing
volume.
Inventory goals:
 Inventory level should be determined by taking technical approaches like:- EOQ model, VED analyses
and ABC analyses, so that over stocking and under stocking situations are avoided.
FINANCIAL OBJECTIVES:
 Improve profitability.
 Improve E.P.S.
 Improve N.A.V.
 Improve dividend payment.
 Optimizing leverages.
 Minimization of cost of capital
 Efficient utilization of short term, long term, and medium term finances.
 Maintaining Liquidity position.
These are the objectives of financial management in co-temporary business environment.

SOURCES OF FINANCE.

Sources of finance for business are equity, debt, debentures, retained earnings, term loans, working
capital loans, letter of credit, euro issue, venture funding etc. These sources of funds are used in
different situations. They are classified based on time period, ownership and control, and their source
of generation. It is ideal to evaluate each source of capital before opting for it.
Sources of capital are the most explorable area especially for the entrepreneurs who are about to
start a new business. It is perhaps the toughest part of all the efforts. There are various capital
sources, we can classify on the basis of different parameters.
Having known that there are many alternatives to finance or capital, a company can choose from.
Choosing the right source and the right mix of finance is a key challenge for every finance manager.
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The process of selecting the right source of finance involves in-depth analysis of each and every
source of fund. For analyzing and comparing the sources, it needs the understanding of all the
characteristics of the financing sources. There are many characteristics on the basis of which sources
of finance are classified.
On the basis of a time period, sources are classified as long-term, medium term, short term.

LONG TERM SOURCES OF MEDIUM TERM SOURCES SHORT TERM SOURCES

FINANCE / FUNDS OF FINANCE / FUNDS OF FINANCE / FUNDS
Preference Capital or
Share Capital or Equity Shares Preference Shares Trade Credit
Preference Capital or Preference
Shares Debenture / Bonds Factoring Services
Retained Earnings or Internal
Accruals Lease Finance Bill Discounting etc.
Term Loans from Financial
Institutes, Government, and Advances received from
Commercial Banks Hire Purchase Finance customers
Medium Term Loans from
Financial Institutes, Short Term Loans like
Government, and Working Capital Loans
Debenture / Bonds Commercial Banks from Commercial Banks
Asset Securitization Fixed Deposits (<1 Year)
Asset Securitization Receivables and Payables

Long-term financing means capital requirements for a period of more than 5 years to 10, 15, 20 years
or maybe more depending on other factors. Capital expenditures in fixed assets like plant and
machinery, land and building etc of a business are funded using long-term sources of finance. Part of
working capital which permanently stays with the business is also financed with long-term sources of
funds. Long-term financing sources can be in form of any of them. International Financing by way of
Euro Issue, Foreign Currency Loans, ADR, GDR etc.

According to Ownership and Control:

Sources of finances are classified based on ownership and control over the business. These two parameters
are an important consideration while selecting a source of funds for the business. Whenever we bring in
capital, there are two types of costs – one is the interest and another is sharing ownership and control. Some
entrepreneurs may not like to dilute their ownership rights in the business and others may believe in sharing
the risk.

OWNED CAPITAL BORROWED CAPITAL

Equity Capital Financial institutions,
Preference Capital Commercial banks or
Retained Earnings The general public in case of debentures.

ACCORDING TO SOURCE OF GENERATION:

INTERNAL SOURCES EXTERNAL SOURCES

Retained profits Equity
Reduction or controlling of working capital Debt or Debt from Banks
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Sale of assets etc. All others except mentioned in Internal Sources

The internal source of funds has the same characteristics of owned capital. The best part of the internal
sourcing of capital is that the business grows by itself and does not depend on outside parties. Disadvantages
of both equity capital and debt capital are not present in this form of financing. Neither ownership dilutes nor
fixed obligation bankruptcy risk arises.
An external source of finance is the capital generated from outside the business. Apart from the internal
sources of funds, all the sources are external sources of capital.
Deciding the right source of funds is a crucial business decision taken by top-level finance managers. The
wrong source of capital increases the cost of funds which in turn would have a direct impact on the feasibility
of project under concern. Improper match of the type of capital with business requirements may go against
the smooth functioning of the business. For instance, if fixed assets, which derive benefits after 2 years, are
financed through short-term finances will create cash flow mismatch after one year and the manager will
again have to look for finances and pay the fee for raising capital again.

TIME VALUE OF MONEY –

Definition:
The money have in hand at the moment is worth more than the same amount in future. The reason for this is
possible earning capacity. The fundamental code of finance maintains that, given money can generate
interest, the value of a certain sum is more if it will receive sooner. This is why it is called as the present value.
Basically, the time value of money validates that it is more beneficial to have cash now than later. Say, if you
invest a Rs. 100 today – the returns will be more compared to the same investment made 2 months from now.
Moreover, there is always a risk that the borrower might delay even more or not pay at all in the future.
This is a practical approach to Financial decision making process.  
Today's technology provides multiple calculators and applications to help & derive both present value and
future value of money. If we do not take the time to comprehend how these calculations are derived, we may
make critical financial decisions using inaccurate data
(because we may not be able to recognize whether the answers are correct or incorrect). 
There are five “5” variables that we need to know:
Future value (FV) - This is the amount at a point in time in the future. It should be worth more than the
present value, provided it is earning interest and growing over time.
FV =PV(1+I)^N
FV = PV x (1 +i/t) ^n*t
{When compounding is more than one in a year (t)}
Present value (PV) - This is the investment amount.  It is the money the investor can invest initially for future. 
PV = FV ÷ (1+i)^n
The number of periods (n) - This is the timeline of investment (or debts). It is usually measured in years, but it
could be any scale of time such as quarterly, monthly, or even daily.
Interest rate (i) - This is the growth rate of the invested money over the lifetime of the investment. It is stated
in a percentage value, such as 8% or .08.
Future value (FV) :
• The Time preference factors enable an Investor to receive money in Present instead of Future.

• The said Investor can wait for some time & in return if he/she will compensated adequately by way of
interest.(Taking inflation rate into account)

• The compensation is called Future value.

• The Inflation adjusted rate of return is called real rate of return.

• Acceptance of proposal depends on real rate of return.

Interest Rates (Future Value) – Types

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• There are many types and forms of interest.  It is critical you know the terminology.  Here are the most
commonly used terms:

• Variable interest rate Mixed interest rate . Fixed interest rate

• Simple interest Compound interest

Fixed interest rate:

• Fixed interest rate is a straight forward rate that remains constant during the life of the loan or
investment.

Variable interest rate:

• Variable interest rate changes during the life of the loan and is usually tied to the prime rate. It can go
up or down depending on the prime rate set forth by the RBI.

Mixed interest rate:

• Mixed interest rate changes from fixed to variable or from variable to fixed. It has some merits
depending on the situation, but it is not a rate one would want to choose for a long-term investment
or debt.

Compounding Techniques :
Simple Interest:
• Simple interest is computed on the original amount as the return on that principal for one time
period. 

• Example: 1,000 /-invested for ten (10) years at 5% simple interest will yield 1,500 /-by the end of
ten years.

1000 + (1,000 x 0.05 x10) = 1,500/-

Compound Interest
• Compound interest is computed on the original amount as the return on that principal plus all unpaid
interest accumulated to date.

• Compound interest is always assumed in TVM problems.

Factors:
• Present Investment (P)

• Expected Future Value (A)

• Interest (I)

• No. of years (n)

Formula: A= P (1+i)^n
Multiple Compounding Techniques: This means the interest are compounded more than once in a year.
Formula: A= P (1+i/m)^m*n
Example: 1,000 /- invested for ten (10) years at 5% interest compounded quarterly (4 times a year) will
yield 1,643.62/- by the end of ten years. 
1000 + ((1,000 x(1.0125)^40) = 1,643.62 /-
• This is much larger than the 1,500 /-obtained through the simple interest calculation.

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• This is a powerful concept that means money can grow at an exponential rate depending on how
often interest is credited to the account. Once interest is credited, it becomes in effect principal.
Hence, it is very critical to understand the compounding frequency of investment prior to committing
money to it.

Effective Interest Rate:

It is the derived interest rate after making all the compounding calculation for the year. The assumption lies
here, more the no. of frequency of compounding per year more will be the effective interest rate.
Formula: {(1+ i/m)^m}-1.
In the above example effective interest rate=
{(1+.05/4)^4} -1= 1.0125^4-1=1.0509-1=.0509=5.09%.
Future value of Deferred Investment:
• Deferred Investment means Investment made regularly/irregularly over a period of time at equal
amount or unequal amount.

• The future maturity period or date is same for this serial investment.

• However for irregular investment the calculation is complex.

• Investment of equal amount is called annuity.

• If the investment made at the end of the period. (Deferred annuity

Formula: An= R1(1+i)^n-1+R2(1+I)^n-2+R3(1+i)^n3+….+Rn.

If the investment made at the beginning of the period. (Annuity Due)
Formula: An= R1(1+i)^n+R2(1+i)^n-1+R3(1+i)^n-2+….+ Rn(1+i)^n-(n-1)
By Using Compound Value Table:
Deferred annuity: An = R* ACF, Annuity Due: An=R* ACF*(1+i).

Present Value: When a Future Payment or Series of Payments are discounted at the given rate of interest up
to the Present date to reflect the time value of money, the resulting value is called Present Value.
Present Value of a Single Sum of Money:
Present value of a future single sum of money is the value that is obtained when the future value is discounted
at a specific given rate of interest. In the other words present value of a single sum of money is the amount
that, if invested on a given date at a specific rate of interest, will equate the sum of the amount invested and
the compound interest earned on its investment with the face value of the future single sum of money.
Formula: The formula to calculate present value of a future single sum of money is:
Present Value (PV) = Future Value (FV)/ (1 + i)^n .
Example 1: Calculate the present value on Jan 1, 2011 of 1,5000/- to be received on Dec 31, 2011. The market
interest rate is 9%. Compounding is done on monthly basis.
Solution
• We have, Future Value FV = 15,000/-.

• Compounding Periods n = 12

• Interest Rate i = 9%/12 = 0.75%

• Present Value PV = 15,000 / (1 + 0.75% )^12 = 15,000 / 1.0075^12 =

15,000 / 1.093807 =13713.60/-.

Present Value of an Annuity
• An annuity is a series of evenly spaced equal receipt made for a certain period of time.

• There are two basic types of annuity known as Ordinary annuity and Annuity due.

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• Annuity due is the one in which periodic receipt are made at the beginning of each period.

• Ordinary annuity is one in which periodic receipt are made at the end of each period.

Formula:
Although the present value (PV) of an annuity can be calculated by discounting each periodic payment
separately to the starting point and then adding up all the discounted figures, however, it is more convenient
to use the 'one step' formulas given below.
PV of an Ordinary Annuity = R × {1 − (1 + i)^-n}/i
PV of an Annuity Due = R × {1 − (1 + i)^-n}/i × (1 + i)
Where,
   i is the interest rate.
   n are the number of periods.
   R is the fixed periodic payment.
PV of an Annuity Due:
Example: A certain amount was invested on Jan 1, 2010 such that it generated a periodic payment of 1,000/-
at the beginning of each month of the calendar year 2010. The interest rate on the investment was 13.2%.
Calculate the original investment and the interest earned.
Solution:
• Periodic Payment R = 1,000/-

• Number of Periods n = 12

• Interest Rate i = 13.2%/12 = 1.1%

• Original Investment = PV of annuity due on Jan 1, 2010

= 1,000 × {(1-(1+1.1%)^(-12))/1.1% }× (1+1.1%)

= 1,000 × {1-1.011)^-12}/0.011 × 1.011 = 1,000 × (1-0.876973)/0.011 × 1.011
= 1,000 × 0.123027/0.011 × 1.011 = 1,000 × 11.184289 × 1.011 = 11,307.32
Interest Earned =1,000 × 12 − 11,307.32 =692.68.
PV of an Ordinary Annuity = R × {1 − (1 + i)^-n}/i
Examples: Calculate the present value on Jan 1, 2011 of an annuity of 500/- paid at the end of each month of
the calendar year 2011. The annual interest rate is 12%.
Solution:
• We have, Periodic Payment R = 500/-

• Number of Periods n = 12

• Interest Rate i = 12%/12 = 1%

• Present Value PV = 500 × (1-(1+1%)^(-12))/1% = 500 × {(1-1.01)^-12}/1%

• = 500 × (1-0.88745)/1% = 500 × 0.11255/1% = 500 × 11.255 = 5,627.54

12