Time Value of Money
Time Value of Money
Time Value of Money
Money Market
Capital Market
• Market value is not a function of EPS - hence maximizing EPS will not
result in highest price for company's shares
• Maximizing EPS implies that the firm should make no dividend payment so
long as funds can be invested at positive rate of return—such a policy may
not always work
Shareholders’ Wealth Maximization
0 1 2 3 4
1000
i = 10% ?
?
?
Multi-Period Compounding
• If compounding is done more than once a year, the actual annualised rate of
interest would be higher than the nominal interest rate & it is called the
effective interest rate
𝑖 𝑛∗𝑚
• EIR = (1 + ) −1
𝑚
(1+𝑖)𝑛 −1
• FV = A [ ] Or FV = A * FVIFA ( Future Value Factor of an
𝑖
Annuity)
Sinking Fund
• Allows businesses that have floated bonds to prevent a large lump-
sum payment at maturity - some bonds are issued with a sinking fund
feature attached to them
• A bond sinking fund is an escrow account (the third party account which holds
the asset until the conclusion of a specific event or time - an independent
trustee) into which a company places cash that it will eventually use to retire a
bond liability that it had previously issued
(1+𝑖)𝑛 −1 𝑖
• FV = A [ ] & A = FV [ 𝑛 ]
𝑖 (1+𝑖) −1
• The factor used to calculate the annuity for a given future sum is called the
sinking fund factor (SFF)
Sinking Fund………
• RLB ltd. desires to create a BSF to retire a bond of Rs.10 million at
the end of 5 years with an effective rate of interest of 12%pa. What
will be the annuity for this BSF?
0 1 2 3 4
?
? i = 10%
?
?
Present Value of an Annuity
• Computation of the PV of an Annuity can be written in the following
form:
1 1 (1+𝑖)𝑛 −1
• P =A [ − 𝑛 ] or A [ 𝑛 ]
𝑖 𝑖(1+𝑖) 𝑖(1+𝑖)
𝑖(1+𝑖)𝑛
• A= P [ 𝑛 ]
(1+𝑖) −1
• Assume that you have borrowed Rs. 10 lakh from a financial institution in the
form of an educational loan at an interest of 14% p.a. The loan is to be cleared in
five equal installments. Prepare a loan amortization schedule.
• Annual Installment = Rs.10,00,000 ÷ PVAF (5, 0.14);
• Rs.10,00,000 ÷ 3.433 = Rs.2,91,290
Example……(Schedule)
(1+𝑖)𝑛 −1
• Future Value of an Annuity Due = CF [ ] * (1+i)
𝑖
(1+𝑖)𝑛 −1
• Present Value of an Annuity Due = CF [ 𝑛 ] * (1+i)
𝑖(1+𝑖)