A

ncial Me
ononear
3

71,000
1,000

1 , 0 0 0

216

of Present Values
llustration
c

Graphic

GURE2.2

SpreadsheetSolution2,7

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in AMicrosof Excel, there is an inbuilt function, PV, for finding the present value of an annuity. In cell B4, enter
tie function =PN(BI,02,100,00) to get the present value of the annuity.
aie A4 can be easily applied to other problems relating to annuity also as shown in Exaunple
.

Example 2.8
AD Company expects to receive
tket.
Asuning a 10 per cent rate of 1,00,000 for a period of 10 vears from a new h a sjust under

Sohution interest, how much would be the

Nerest, proje
present value of this ann y
th aprupruate ADF
(annuity
6145. irepresenting tine discount factor) of a
row

oanmuiMulny ipishyi6,n1g4500.
10
this factor bypeñitheod) against
n the
anmigthisfactor against the
the 10 year
10 per annuity at 10 per cent is to be found ro
Let us annuiityty interest column from Table A-4. This
wotked outtake an example to
amount of
R1,00,000, find that the of the presentvl
we
Example 2.9(Example 2.9). clarify how
sum
de
the
ABC
t200company s cash
problems involving cash inflows
are
to
be

T the nest and {I50expect 1g

eight years, 000 for the ifirst
nflows from its
w'iut
would be the years investment
two
ment proposal
presentntrevalue
spectivofely andpropoda
then
it has
underta
undertaken in
ime period zer
expects of 1,00,00
cash
inflows,cP annuity
yment Uerest

assuming a 10 per cent rate

of inic
-

Pv A -
AN)

- oos

9160u1:S93 loto (6-

0 S 3 6,H300.

Sou-7 22

D10(11S

O
0(10

M08 Z017 181818 818

6.2
--

150 DyoK6 86 14200

Time Value of 2.19
Money
1. A financial managcr is often interested in detemining the size of annual payments to accumuiate
a future sum to repay an existing liability at some future date or to provide funds for replacement
of an existing machine/asset after its useful life. Consider Example 2.11.
Example 2.11
today from
CompaTy AYZ 1s establishing a sinking fund to retire 5.00.000. 8 per cent debentures, 10 years
will de
The coTipany plans to put a fixed amount into the fund each year for 10 years. The first payment
what
made at the end of the current year. The company anticipates that the funds will earm per cent a year.
6
equal annual contributions must be made to accumulate R5.00.000. 10 years trom now
Solution
the of finding the compounded sum of an annuity.
The solution to this problem is ciosely related to process
at
Table A-2 indicates that the annuity factor for 10 vears at 6 per cent is13.181. That is, one rupee invested
In order to have
the end of cacth year for 10 years will accumulate to R13.181 at the end of the 10th year.
is deposited at the
5,00,000 the required amount would be 75,00.000 + 13.181 =737,933.39. If 737,933.39
cnd of cach year for ten years, there will be 75,00.000 in the account.
ouy. 6. dakou

s0 D 2{
O06

1318o13180
34836-26
Tancla
ultiplying ving the annual amoun
nd by C (ADF), or C= PlA C#
amount C i s
fo

is,
P=

annuity facto
ADF iinn whh
PlADF
Table
A-4
that
value f an
of.

the values5, correspo

annuny present

A4,
Substituting
Subs we have
is the P
the A-4.
(ADF
is
ADF)
n y e a r Table

F
Ram ictor ALDF
firo m

discount(iIO02O)
f o
C 1 0 , 0 2 , 0 0 0 / 3 . 6 0 5= { 2 7 7 , 3 9 3

SCen

repay the
1ahre AS

Prwtamuiy
is
,005
to principal and
intets
s
thal
years

for 5
vanbe

nynit a n

I h s

year
cæn

of
1 2 / r
e n d

and the
HINA at
paid
be
to cent.

6
393 per
.
rate of12
the
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Tie solution is similar to that in the previous example. There is only one difference. In the preceding exampk
te san o be acamhted represented a future value. In this problem, the loan represents a present vahe.
MIA Wihlie using thePMTfunction, PV is to be entered as B3 and FV is to be entered as 0. The entry in cell
wll le -PMTBI,82,-B3,0,0). The result would be the
amount of annual installment.
5. At mestor often be interested in
may the rate of
any over a penod of time. It is because growth in dividends has a significant
finding
in dividend paidonbyu a
bearing growth
me othe shanes. In such a situation compound
Example(2.13) interest tables are used. Let us illustrate t

Example
Mtr X
2.133
wishes to
CMpANy: determine the rate of
growth of the
following stream.
ream of
dividends he has
received from a

Year

Dividend (per share)

2.50
2 Solatiom 2.60 1
Growrth has 2.74
dinvidend been
Compound factoexper
us received
year ienced
a in for
2.88} 3
has four
5 3.04) 4
r wch
which been years. In is
1,216 diR3%
1,216 vided order
R304 by the to
amount
+250). ofdetermine this
amou rate of growth, the amou
Now, dividend we
have to receive
eived in the first year.
look
Thisg

gives
tne
at
Table A-1 which
Time Value of Money
2.21
compounded valucs of Ri at various rates of interest (for our
purpose the growth rate) and number of years.
We have to look to the compound factor 1.216 against fourth year in the row side. Looking across year 4 or
Table A-1 shows that the factor for 5 per cent is exactly 1.216: therefore, the rate of growth associated with
the dividend stream is 5 per cent.

Spreadsheet Solution 2.11

Microsof Excel-Booki
Ele Edlit ew Insert Format Tools Data ndow Help Muance PDE Adobe PDF

100% rial
C6
B E
Time 3
2 Cash Flow -2.5 2.6 2.74 2.88 3.04
3 GrowMh rate 0.05

To find out the growh rate, the Excel function RATE can be used. The equation of this function in Excel
format is RATE (nper, PMT, PV, FV, Type, Guess). The initial figure is entered as a negative figure as has been
done in cell B2. In cell B3, the function is entered as -RATEC(F1-B)0,82.F2,0). The 'guess' input is to be left
blank. The result would be the growth rate.
4. To determine the current values of debentures, the present value Tables A-3 and A-4 can be
of immense use. The cash flow from a debenture consists of two parts: first, interest inlows at
periodic intenvals, say, semi-annually or annually and, second, the repayment of the principal on
manurity. Since the interest payments on a debenture are made periodically throughout its life, it
is easy to calculate the present value of this annuity type interest inflow by consulting Table A-4
and the present value of the face value of the debentures can be ascertained by discounting it at
the market rate of interest by consulting Table A-3. The sum of the two values so obtained will be
curent worth of a debenture. If the interest is paid after six months, the factors are obtained for
one-half of the discount rate and the number of years is doubled. Consider Example 2.14.
Example 2.14
Suppose a particular debennure pays interest at 8 per cent per annum. The debenture is to be paid after 10 years
afa premium of 5 per cent. The face value of the debennure is R1,000. Interest is paid after every six months.
What is the current worth of the debenture, assuming the appropriate market discount rate on debentures of
similar risk and matruriry is equal to the debenture's coupon rate, that is, 8 per cent?

Solution
Sunee the interest is compounded semi-annually over 10 years, the relevant compounding period equals to
20 and the discount rate will be one-half (4
per cent) of thhe yearly interest of 8 per cent. In other words,
the investor will have an of 740 (4
annuity per cent of R1,000) for a compounding period of 20 years. The
present value factor for 20 years and 4 per cent from Table A-4 is 13.59 which, when multiplied
by 40, gives
us a
present value for the interest cash flows of R543.60. The present value of a maturity value of F1,050 (as
the debenture is to be redeemed at 5
per cent premium) will be found by multiplying 1,050 by the factor
for the present value of 1 to be received 20
years from now at 4 per cent. The relevant present value factor
from Table A-3 is 0.456.
Multiplied by R1,050 maturity value, it gives us a present sum of R478.8. The total
value of the debentures would be
equal to the total of these two values, that is, 7543.60 + {478.8= F1,022.4.
Example 2-A3
Assuming(a) i- 0.0125 and (6) 12 = 0.1025, find the values of (1) and (2) 12)

Solution
(a) = (1.1025)A- 114
0.0988 9.88 per cent

b) 0.1025 -1 0.0151 10.51 per cent

2
f12 =[(1.051/12- 1) 12 =
0.1004 10.04 per cent
=

Similar to the
relationship between the nominal and effective
relationship between effective and nominal rates rates of interest, the mat
The nominal rates of of discount is
interest and discount rate given by Equations 2-A4 2
payable P-thly. emplóved in computing the present value of

d1-1d p.
and

Where
d
Example 2-A.4 1+i
Assuming d2) 0.12 and
=

(i¥ =
0.12 find the
Solution value of (a) d
and (b) a
(a) d
(b) (= 0.12 =0.1136 11.36 per
=

cent
i-
(1.06 11 0.1236
Example 2-A.5
The current lease rates quoted by the First Leasing Ltd (FLL) on its lease contracts are: () 18/R1,000/month and
) 12.5/1,000/month for 3-year and 5-year terms respectively. While the monthly lease rentals on the 3-year
conract are payable in arrears, those for the 5-year contract are payable in advance. Assuming 10 per cent
marginal cost of debt to the lessee, calculate the present values of the lease payments.

Solution
(a) Present value of lease payments on the 3-year contract (in arrears)
=
(18 x 12) x PVIFA,, (10,3)
- 216 x 12) x PVIFA (i, 3) where i= 0.10 (10%)

= {216 x 1.045 (Table A.5) x 2.487 (Table A-4) = 7561

b) Present value of lease payments on the 5-year contract (in acdvance)

=
12.5 x 12) x PVIFA,, (10,3)
R150 x x PVIFA (i, 5) where i =0.10
dP)
-
R150 x 1.0534 (Table A-5) x 3.791 (Table A-4) -
R599
once a yli

payable (a)
iO0/K1,000
payable
annually in arrears.
a
Assuming no salva
Erample 2A6 lease
rentals for a
5-year
contract
are
contract
and develop
a
amor
schedule.
The lease interest implied
by the
the rate of
compute

(, 5) F1,000
=
PVIFA
Solutton R300 x
i
=

of interest, at 15 per cent)

The implied
rate
to 3.333 is 3.52
PVIFA closet
PVIFA 5) 3.333 (The
( =

3.352
(Table A-4)
=

PVIFA (15, 5)
cent.
Therefore, i = 0.15 15 per Lease Amortisation Schedule

Instalment
Interest content Capital content
Outstanding amount
Year (0.15)
at the beginning
300 150 7150
1,000 128 172
850 300
2 102 198
678 300
3 72 228
480 300
4
300 38 262
5 252

Example 2-A.7
A hire-purchase plan requires a hirer to pay 91.68 per tho'isand per month (ptpm) in arrear over a 12-month

period. Assuming a cash purchase price of R1,000 and no salvage value (a) compute the effective rate of
interest

implied by the plan, (6) develop the repayment schedule from the viewpoint of the hirer and (C) calculate the
effective and the nominal rates of interest per annum

Solution
(a) The implied effective rate of interest,
91.68 x PVIFA ( 12) {1,000 =

PVIFA (G12) = 10.9075

PVIFA (1,12) 11.255 (Table A-4) and PVIFA (2,12) =
10.5753 (Table A-4)
By interpolation,
001001x10.9075-11.2551)]
i-0.01 10.5753-11.251

b)
-001+001x00015 -15 per cent
Loan Repayment Schedule
Month
Beginning amount cote

1,000 Instalment interest content (1.5) Capital

2 7 6 6 8

923.32 91.68 715.00 77.83

845.49 91.68
4 13.85 79.00

768.49 91.68
12.68 80.18
91.68
11.50 (Contt)
Time Value of Money
2.27
(Conta)

686.31 91.68 10.29 81.38

6 604.93 91.68 9.07 82.61
7 522.32 91.68 7.83 83.85
438.47 91.68 6.58 85.10
353.37 91.68 5.30 86.38
10 266.99 91.68 4.00 87.67
11 179.32 91.68 2.69 88.99
12 90.33 91.68 1.35 90.33

(c) Effective rate of interest and nominal rate of interest per annum
Effective rate of interest (1.015)2 - 1 = 0.1956 = 19.56 per cent
Nominal rate of interest per annum = 0.015 x 12 = 0.18 18 per cent

Example 2-A.8
A lease contract involves payment of R27 pm at the end of every month over a 5-year period. Develop a

annual repayment schedule inherent in the contract.

Solution
Annual rate of interest (i) = (R27 x 12)x PVIFA,, ( , 5) = T1,000

(, 5) 3.086 R1,000 7324 T27 x 12)]

PVIFA =

or 1 2 ) x PVIFA ( , 5) = 3.086

(12)
PVIFA (22,5) = 3.142 (Table A-4) and PVIFA (24,5) = 3.035 (Table A-4) are the closest values to 3.086

By interpolation,

i=0.22+0.02 x
(3.086-3.142|-0.2305
3.035-3.142| =23.05 per cent
12) =[(1.23051/12 1] x 12 =
0.2092 20.92 per cent

Equivalent annual interest instalment

0.2305
= 2 7 x 12 x 0.2305(12) R 3 5 7

Repayment Schedule Based on Equivalent Annual Instalments

Year Equivalent annual Interest content Capital content

Outstanding amount
at the beginning instalment (0.2305)
357 230.5 T126.5
71,000.0
2 357 201.3 155.7
873.5
3 357 165.5 191.5
717.8
4 121.3 235.7
526.3 357
67.0 290.6
290.6 357

7357
the interest on interest of 33 li.e.
-

quired repayment schedule can be obtained by deducting

based on equivalent annual
*12)I from the interest and instalment amount of the repayment schedule
instalments.
Time Value of Money 2.31

SOLVED PROBLEMS
p.2.1 An investor deposits R100 in a bank account for 5 years at 8 per cent interest. Find out , LOD
the amount which he will have in his account if interest is compounded (a) annually (b) Seni
annually (6-monthly), (C) quaterly and (d continuously.
Solution F P1+ imjn x m =PxFVIF
(a) Annual compounding (m= 1: F - 100 (1 0.08/1- R100 (1.4693)- t146.93
(b) Semi-annual compounding (m = 2): F = 100 (1 + 0.08/2)5x2 = Px FVIF 10 R100(1.4802)
T148.02
(Quarterly compounding (m =4): F = 100 (1+0.08/4x4 = P x FVIF, R100(1.4859)
R148.59
(d) Continuous compounding: F. = Px é x r = F, - T100 (2.71828)008 5 = TI00 (2.71828)
100 (1.4918) R149.18
P.2.2 If the discount/required rate is 10 per cent, compute the present value of the cashflow streams detailed
below (a) ti100 at the end of year 1; (b) 100 at the end of year 4; (O R100 at the end of LO23 LOD

year 3 and id year 5 and (d) Ri00 for the next 10 years (for years 1 through 10). M

Solution P-F, l1/0 +i-F, x PVIF,

(a) R100 at the end of year 1= R100[1/(1.10)] R100x PVIFa1 = R100 x 0.9091 R90.91.
b) Ri00 at the end of year 4 =7100[1/(1.10] - Ri00 x PVIFo4 R100 x 0.683- R683
(c) R100 at the end of () year 3 and (i) year 5 R100[1/(1.10)] + 710011/(1.10)) R100 x PVIF10
+(100 x PVIF 0)R100 x 0.7513) + R100 x 0.6209)- R75.13 +762.09 R137.22.
(d) Ri00 for the next 10 years (annuity)
PAxPVIFA, R100 x PVIFA0 10R100(6.1446) =
7614.46.
P.2.3Compute the present/discounted value of the following future cash inflows, assuming a required rate of
10per cent: (a) R100 a year for years 5 through 10 and b) R100 a year for years 1 through 3, LOD

nilin years4 through 5 and R100 a year for years 6 through 10. LO 2.3 M
Solution
Ga)P-R100PVIFA1 R100PVIFA,)=R1006.1446)-1003.1699)=R614.46- 7316.99
= T29747.
b) P-T10oPVIFA)R10OPVIFAa)-R100PVIFA,= R100 x 2.4869) +(100
x 6.1446)- 100 x 3.7908) = R248.69+ R6l446- 379.08) =R248.69 +R235.38
= R484.07.

P.2.4 An executive is about to retire at the age of 60. His employer has offered him two post- LOD
etirement options: (a) R20,00,000 lump sum, (b) R250,000 for 10 years. Assuming 10 per centLO2.4 M
interest, which is a better option?

Soution P, =Ax PVIFA=P=z2,50,000 PVIFA,1=2,50,000(6.1446) =R15,36,150.

Since the lumpsum of T20,00,000 is worth more now, the executive should opt for it.
P.2.5 Compute the present value of a perpetuity of 100 year if the discount rate is 10 per LO 2.3
Cent

Solution Present value of a perpetuity= Ai= R100/0.10=R1,000

P.2.6 ABC Ltd has R10 crore bonds outstanding. Bank deposits earn 10 per cent per annum. The bonds will
be redeemed after 15 years for which purpose ABC Lrd wishes to create a sinking fund. How
much amount should be deposited to the sinking fund each year so that ABC LId would have LO 2.4 M
in the sinking fund R10 crore to retire its entire issue of bonds?

Solution 4=S/FVIFA S R10crore/FVIFA015R10crore/31.772 73,14,742.54.

2.32
Financial Management
P.2.7 ABC LId has borrowed
T30,00,000 from Canbank Home Finance Ltd to finance the purchase of
for 15 years. The rate of interest on such
loans is 24 per cent per annum. a housae
of annual payment/instalment. Compute the amount
LO 2.4 LOD
Solution P AX PVIFA,
A=
P.2.8 XYZ Ltd has
P/PVIFA,
= P1s -

30,00,000/PVIFA4 15 30,00,000/4.0013 =R7,49,756.32. =

borrowed 75,00,000 to be
both). The rate of interest is 16 repaid in fival equal annual payments (interest and
per cent.Compute the amount of each payment. principal
Solution
A=P/PVIFA,,= P-/PVIFA16 S = LO 2.4 M LOD

P.2.9 Assume the rate of 75,00,000/3.2743 71,52,704.39

interest is 12 per cent.
=

interest is paid (a)

(b) semi-annually, (c) Compute the annual percentage/effective rate (AP/ER) if
implications of moreannually,
frequent payments of interest? quarterly and (d) monthly. What are the
Solution AP/ER (1 |LOA LOD
D
(a) Interest paid at the+/m)m - 1.0
=

end of the
AP/ER =(1 +0.12/1) 1.0 year (m 1): =

1.12 1.0
-

(6) Interest paid at the end of each 0.12 =

12 per cent
AP/ER (1 6-month period (m
(C) Interest
+
0.12/2 1.0 =
(1.06) 1.0
-
=
2):
paid 1.1236
-

at the end of each 1.0 =

0.1236
AP/ER (1 quarter (m 4):
=

12.36 per cent.

(d) Interest paid at0.12/42
=
+
-1.0 (1.03) 1.0 -

the end of each 1.1255 1.0

AP/ER =(1 + 0.12/12)12 1.0 month (m =

12):
=

0.1255 12.55 per cent.

(1.01)12 - 1.0
Implications: More
frequent payments
=

1.1268 1.0 =

0.1268 12.68
borrower-company.
P.2.10 The
increase the
effective annual cost
per cent.

4.02. earnings of
Fairgrowth Ltd were R3 per share (AP/ER) paid by the
Compute the rate of growth or in year 1.
share. compound annual They increased
rate of over a
Solution growth ot the 10-year period to
earnings per
F FVIF; P x LO A2.4 LOD D
FVIF,= F/P
FVIF 10 R4.02/73 =1.340
According to Table-1
annual rate of
growth in (Appendix),
an FVIF
per share is, or l.540
at
earnings
P.2.11 Mr X has
71,00,000 to
therefore, 310peryears
cent.
is at 3
per cent
interest. The
i) semi-annual deposit in a bank account for compound
of 4 per
cent, compounding and (iii)
quarterly years. 3
compute statedASsuming
compounding
(a) the amount he () annual
at a
interest paid
alternative,
on
and (c) which
deposits in the
would have
bank, (6) the the end of
effective rate of
annual interest
the third
at
rate
year, leaving all
compoundino3
plan should he choose? interest he would LO
Solution earn on each
ac
2.40D
D
(a) ) Compound/future value (FV,) {1,00,000x FVIFA (4,3)
=

(a) (i) FV,

71,00,000x FVIFA (4/2, 2 R1,00,000
=
= x
1.125 71,12,500 =

x 3)
T1,00,000
=

(a) ii)
{1,00,000 x 1.126 T1,12,600
=
x FVIFA
(2,6)
=

FV, 71,00,000 x FVIFA (4/4,3)

=

1,00,000 x 1.127 71,12,700R1,00,000 x PVIFA (1,12)

=
=

(b) ) Effective rate of

interest = (1 4%1) 1 (1.04)-1. + -
=

(b) (i) 1.04 1 0.04 4 =

=
=
(1 4%/2)2 1
+ per cent
=
0.0404
(1.02) 1 1.0404 1
=
=
-

=
4.04 per cent
NA8ANBUJe Nguo

A x+-01

s o
B e A x L l t o . -

b61
A lbo?
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65

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-
d E A R 1 + A R R

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12

1D
(142-5 612 12