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Solved Example TVM

The document discusses compound interest calculations over multiple time periods using formulas and tables. It includes illustrations of calculating future and present values of lump sums deposited in banks at various interest rates over several years.

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Mudit
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© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
23 views

Solved Example TVM

The document discusses compound interest calculations over multiple time periods using formulas and tables. It includes illustrations of calculating future and present values of lump sums deposited in banks at various interest rates over several years.

Uploaded by

Mudit
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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0 .

ILLUSTRATION 2.1: Future Value of a Lump Sum


Suppose that Rs 1 ,000 are placed in the savings account of
a bank at 5 per cent interest rate. How much shall it grow
at the end of three years? It will grow as follows:

, F1 = 1,000.00+1,000.00 x 5%
,'
:,- = 1,000.00 + 50.00 = Rs 1,050.00
f
F2 = 1,050.00+1,050.00 x 5%
5
= 1,050.00 + 52.50 = Rs 1,102.50
i
F3 = 1,102.50 + 1,102.50 x 5%
= 1,102.50 + 55.10 = Rs 1,157.60
Notice that the amount of Rs 1,000 will earn interest
of Rs 50 and will grow to Rs 1,050 at the end of the first
1
year. The outstanding balance of Rs 1,050 in the beginning
r of the second year will ,earn interest of Rs 52.50, thus
1 making the outstanding amount equal to Rs 1,102.50 at
the beginning of the third year. Future or compound value
at the end of third year will grow to Rs 1,157.60 after earning
interest of Rs 55.10 on Rs 1,102.50. In compounding,
interest on interest is earned. Thus the compound value of
l Rs 1,000 in the example can also be calculated as follows:

l F, = 1,000 x 1.05 = Rs 1,050


F; = 1,000 X [1.05 X 1.05] = 1,000 X 1.052
= 1,000 x 1.1025 = Rs 1,102.50
F3 = 1,000 x [1.05 x 1.05 x 1.05] = 1,000 x 1.053
= 1,000 x 1.1576 = Rs 1,157.60
-'-':4-'-6''" \..VHlfJUWlU va1ue.

·ILLUSTRATION 2.2: Future Value of Bank Deposit


If you deposited Rs 55,5 50 in a bank, which was paying a
15 per cent rate of interest on a ten-year time deposit, how
much would the 'deposit grow at the end of ten years?
We will first find out the compound value factor at 15
per cent for 10 years. Referring to Table 2.1 (or Table A at
the end of the book) and _reading tenth row for 10-year
period and 15 per cent column, we get CVF of Re 1 as
4.046. Multiplying 4.046 by Rs 55,650, we get Rs 225,159.90
as the compound value.
We can use Equation (3) for calculating the future
value:

FV = 55,650 x. CVF10 , .0 _12 -

= 55,650x4.046 = Rs 225,159.90
le yve could obtain the same answer by using a scientific
er calculator
Df F10 = 55,650 x 1.1510 =55,650 x 4.046 = Rs 225,159.90
1e
1ri
ILLUST,RATION 2.4: Present Valli$.of a L~~p Su'!'.. ·
Suppose an investor wants to find out the present value of
Rs 50,000 to be received ·after 15 years. The interest rate is
9 per cent. First, we will find out the present value factor
from Table C. When we read row 15 and 9 per cent column,
we get 0.275 as the present value factor. Multiplying 0.275
by Rs 50,000, we obtain Rs 13,750 as the present value:
PV = 50,000 x PVF15009 = 50,000 x 0.275 = Rs 13,750
.ll4L1\l;s!A'~.. .
?%'• ., ·,· ...,: . v F .,,,, .
.\"$·
,AZl
. ,, . :"';t~ \,, , ceiving .
Consider that an investor has an opportunity of re ·vel .
Rs 1,000, Rs 1,500 Rs 800 Rs 1100 and Rs 400 respecti yt
at the end of one 'through' five ' years. Find out th e presen,
value of this stream of uneven cash flows, if th e. inve
· stars•
required interest rate is 8 per cent.
The present value is calcutated as follows:

1000 1,500 800 1,100 400


.Present value=--+---+---+ )4 + ( OB)s
2 3
(1.08) (1.08) (1.08) (1.08 1. .
The complication of solving this equation can be
resolved by using Table Bat the end of the book. We can
find out the appropriate present value factors (PVFs) either
from Table B (at the end of the book) or by using·a calculator
and multiply .them by the respective amount. The present
value calculation is shown below:

PV = 1,000 PVF1,.08 + 1,500 X PVF2,.08 + 800 X PVF3,,Q8


X

+ 1, 100 X PVF4,.08 + 400 X PVF5,.08


= 1,000 X ,926+1,500 X ,857+800 X .794
+1, 100 x .735+ 400 x .681 = Rs 3,927.60
I •PROBLEM 2.5 \ How long will it take to double your
mon~y if it grows ~t 12 per cent annually? _
. ' '

SOLUTION: Fn =-p x CVFn,1.


· ,2 = 1 X ~VFn,O.lZ (

t
2 = CVFn.012
]
From Table A, rthe factor nearest to_2.00 is CVF~.0.12 ·= l
1.974. Therefore, n 6. years. - 1

I PROBLEM 2.6\
, for Rs 10. It isno~
Mohan' bought a' share 15 years ago
·s elling for Rs 27.60. What is the
compound growth rate in the price of the share?

SOLUTION: , Fn = P(CVFn,i) ,
27.60 = 10(CVF15,j)
27 60
CVF15,1. = 10
· = 2,760
\

From Table A, i = 7%.

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