Time Value of

Money
What is TVM?

– Value of a unit of money is different at different time

periods.

Time Value of money implies the value of money received

today is different from the value of money received after
some time in future.

Financial Management is future oriented as its objective is

wealth maximisation hence for decision making Time Value
of Money need to be considered.
Time Value of Money

– Would you prefer Rs.1,00,00,000 now or after 1 year?

– Why ?
Reasons why a Rupee tomorrow is
worth less than a Rupee
today
– Preference for current consumption/personal consumption

– Inflation

– Uncertainty/Risk

– Opportunity cost
Applications of TVM

– Capital Budgeting
– Working Capital Management
– Valuation
– Mergers & Acquisition
– Investment Planning
– Retirement Planning
– Loans
Basic Concepts related to TVM

Future Value : Amount of Cash Flow receivable in future for

present investment.

Present Value : Value of future cash flow in present.

Interest : For Calculation of both Present Value and Future

Value Interest is considered.

Interest is paid to compensate for the risk of lending money

by the borrower to lender.
Two Types of Interest :
Simple Interest &
Compounding Interest
Simple Interest

Interest = Principle x Rate x Time

1. Mr. Rahul has deposited Rs. 100,000 in a savings bank account at 6

per cent simple interest for 2 years. Calculate the Maturity value.

– Solution: After 2 years he will get:

Amount of Investment + Interest for 2 years
100000 + (100,000x6/100x2 years) = 112000
 Compound Interest
It is interest on the original amount and on interest accrued
previously but not paid or received.

Interest = Amount on maturity – Amount invested

2. Now assume compound interest At end of year 1: = 100000 +
6000 = 106000

Reinvesting 106000 for year 2

At end of Year 2: = 106000 + (106000*6/100)
= 106000 + 6360 = 112360
OR
Maturity = 100000*(1+0.06)^2 =
112360…

Interest = 112360 – 100000 = 12,360/-

Techniques of Conversion:

–
Compounding
FV = PV*(1+r)n

OR (1+r)n = compounding factor

FV = PV X CF

Where,

FV = Amount or future value after ‘n’

years
PV = Principal or cash flow today
r = Nominal Interest rate per
annum
n = Number of years for which
compounding is done
Techniques of Conversion:

– Discounting
PV = FV / (1 + r)n

OR
[1/(1 + r) ^ n] = the
discounting factor
PV = FV * 1
(1 + r)n

PV = FV x DF

Where:
PV = present value (today's value),
FV = future value (a value or cash flow sometime in the future),
r = interest rate per period, and
n = number of compounding periods
Time Value of Money

FV = PV x CF (compounding factor)

PV = FV x DF (discounting factor)
Future Value
 Future value of a single amount

3. Ms. Laurel has invested Rs. 10,000 in a Bank

certificate of deposit for 2 years at 8% interest. How
much will she receive on maturity?

Ans: FV = PV x (1+r)^n
FV = 10000 x (1+0.08)^2
OR
FV = PV x FVF(r,n)
FV = 10000 x 1.1664 = Rs. 11664 at maturity of 2
years (also see table)

– Note: Answers are approx and may vary marginally

due to decimals
4. Mr. Aryan deposits Rs. 100,000 with a bank which pays 10
percent interest compounded annually, for 3 years. How much
amount he would get at maturity?

Ans: FV = PV x FVFr,n
FV = 100000 x (1+0.10)^3
OR
FV = 100000 x 1.331 = Rs. 133100.
He will get this amount after 3 years. (see table)

alternatively, FV = 100,000 * FVF10%,3 years

 Multiple compounding in one year
If Interest is receive for more than Once in a year then the Effective
maturity value is calculated as follows:
FV = PV* (1 + r / m)n *m
Where,
m = no. of times of compounding in a year
r = rate of interest per annum
n = No. of years
n*m = Total number of compounding in all for the given period
Example: How much will be in an account at the end of five years the
amount deposited today is Rs 20,000 and interest is 8% per year,
compounded semi-annually?
FV = 20000 x (1 + 0.08/2) 5 *2
FV = 29605.
With Tables it becomes: FV = 20000 x FVF4%,10 yrs
 Frequency of Compounding
– Interest rate can be quarterly (4) , semi annually(2) or monthly (12)

– If r=10% p.a. & n =2 years

– Effect of different frequency in compounding:

Quarterly Semi Annually Monthly

Effective r 10/4= 2.5 10/2= 5 10/12= 0.83

=r/m
Total No. of 2*4= 8 2*2= 4 2*12= 24
compounding
in the given
period
 Practice……
1. How much will be in an account at the end of five years the amount
deposited today is Rs 10,000 and interest is 8% per year,
compounded semi-annually?
Effective R = (Rate of Interest / Compounding in a year) = 8 / 2 =
4
Total Compounding = (Compounding in a year x no of years)
2 x 5 = 10
Amount on Maturity = 10000 x (1+ 0.04)^10 = 14,802/-
2. Calculate the compound value when Rs. 10,000 is invested for 3
years and 10% per annum is compounded on quarterly basis
Effective R = (Rate of Interest / Compounding in a year)
= 10 / 4 = 2.5
Total Compounding = (Compounding in a year x no of years)
4 x 3 = 12
Amount on Maturity = 10000 x (1+ 0.025)^12 = 13,449/-
Present Value
 6. Find the present value of Rs. 50,000 to be received at the
end of four years at 12 per cent interest compounded

Ans:
PV = FV x PVFr,n at 12%
PV = 50000 x 0.636 (see table)
PV = 31,800
Or:
We know:
PV = 50000 x [1 / (1+0.12)^4]
10,000 X(1/1.57351936)

PV = 50000 x 0.6355
PV = 31,776 (approx.)
 PRESENT VALUE of a Single amount

PV of a future cash flow is the amount of current cash that is

EQUIVALENT value to the decision maker.

5. Find the PV of Rs. 10,000 receivable after 6 years, if the rate of

interest is 10 per cent. Assume compounding of Interest.
Ans: PV = FV x DFr,n [also, DF = 1 / (1+r)^n]
PV = 10000 x [1 / (1+0.1)^6]

10,000 X(1/1.771561)
PV = 10000 x 0.5645
PV = 5645
 Present value of an uneven series of payments
7. Find the PV of the following cash flows streams. The discount rate is 10 per
cent.
Year Cash Stream
1 1000
2 4000
3 4000
4 4000
5 3000

Year Cash Stream PVF PV Inflow

1 1000 0.909 909
2 4000 0.826 3304
3 4000 0.751 3004
4 4000 0.683 2732
5 3000 0.621 1863
Total 11,812
8. Mr. Shah has invested Rs. 50,000 on Xerox machine on 1.1.2012. He estimates net cash income
from Xerox machine in next five years as under.
Year Estimated Inflows
2012 12000
2013 15000
2014 18000
2015 25000
2016 30000
Calculate the PV of all future cash flows
Ans:

Year Estimated Inflows PVF @ 10% PV of Inflows

2012 12000 x 0.9091 = 10909

2013 15000 x 0.8264 = 12396
2014 18000 x 0.7513 = 13523
2015 25000 x 0.6830 = 17075
2016 30000 x 0.6209 = 18627
PV = sum = 72530
1. Rahul has an option to receive the value of Rs. 800, today for a debenture, having a
Face value of Rs. 1000 carrying interest of 10% per annum or on maturity with Face
value, where the debenture falls due for payment after three years. Calculate the
present value today. Should he redeem the debenture today or wait for 3 years.
Year Inflow PVF PV Inflow
1 100 0.909 90.9
2 100 0.826 82.6
3 1100 0.751 826.1
Total 999.6
PV inflow is Rs. 1000, hence he should hold it for 3
years
2. A project involves an initial investment of Rs. 8,00,000 and generates net cash flows
as follows: At end of Year 1:Rs. 200,000, Year 2: Rs. 400,000 & Year 3: Rs. 600,000. What
is the total present value of the future cash flows where the cost of capital or interest
rate is 9%?
Year Inflow PVF PV Inflow
1 200000 0.917 1,83,400
2 400000 0.842 3,36,800
3 600000 0.772 4,63,200
Total 9,83,400
– A project involves an initial investment of Rs. 8,00,000 and generates net

cash flows as follows: At end of Year 1:Rs. 200,000, Year 2: Rs. 400,000 & Year
. 3: Rs. 600,000. What is the total present value of the future cash flows where
the cost of capital or interest rate is 9%?

Year CF Dis factor@9% (1/(1+r)^n) Total

1 200,000 0.917 1,83,400

2 400,000 0.842 3,36,800

3 600,000 0.772 4,63,200

Total CF 9,83,400
Annuity
 Future value of an Annuity

Annuity is a fixed payment (or receipt) each year for a specified number of years.

Examples: a) if you rent a flat and promise to make a series of payments you have
created an ANNUITY.
b) The EMI payments for a loan

FVA = A * [ {(1+r)n – 1} / r]
where A = annuity/periodic cash payments,
r = annual interest rate.

OR

FVA = A x FVAFr,n [table factor]

9. Four equal annual payments of Rs. 5,000 are made
into a recurring deposit account that pays 8 per cent
interest per year. What is the future value of this annuity
at end of four years?

Ans: FVA = 5000 x (FVAF8%,4)

Ans: 5000 x [ {(1+0.08)4 – 1}/0.08 ]
FVA = 5000 x 4.506 (see table)
= Rs. 22530

IN Excel –
FV = (0.08,4,-5,000,0,0)
 10. Mr. S. K. Shukla decided to deposit Rs. 30,000 per year
in his Public provident fund account for 15 years. What
will be the accumulated amount in the PPF A/c at the end
of 15 years if the interest is 8 percent?

Solve:

FV = A x FVAF
A 8%,15 years
Ans: 30000 x [ {(1+0.08)15 – 1}/0.08 ]

= 30000 x 27.152
= Rs. 814563(approx.)
11. A bank advertises that it will pay a lump sum of Rs. 45740 at
the end of 8 years to investors who deposit annually Rs. 4000
for 8 years. What is the rate of interest rate bank is paying?

Ans: The Interest rate is calculated in two stages:

i) Find FVAF for 45740.

FVA = A x FVAF
FVA = A * [ {(1+r)n – 1}/r ]
45740 = 4000 x [ {(1+r)8 – 1}/r ]
45740 = 4000 x (FVA)
= 45,740/4,000
FVAF = 11.435
11.435 = [ {(1+r)8 – 1}/r ]

(ii) Look for 11.435 in FVAF table, the rate closet to it is the interest rate. In this case we get
FVAF 10%, 8 years = 11.435 and hence the Interest rate = 10%.
In excel Rate = (N,PMT,FV)
Practice: -You want to buy a house in Kharghar after 5 years, when it is expected to cost ₹
2 million. How much should you save annually if your savings earn a compound return of 12
percent?

Practice: PVR Limited has an obligation to redeem ₹ 500 million bonds 6 years hence. How
much should the company deposit annually in a sinking fund account wherein it earns 14
percent interest, to cumulate ₹ 500 million in 6 years time?

1. FVA = A * [ {(1+r)n – 1}/r ]

20,00,000 = A x [ {(1+0.12)5 – 1}/0.12 ]
20,00,000 = A x 6.353
Annuity = 20,00,000 / 6.353
Annuity = 3,14,819

1. FVA = A * [ {(1+r)n – 1}/r ]

50,00,00,000 = A x [ {(1+0.14)6 – 1}/0.14 ]
50,00,00,000 = A x 8.536
Annuity = 50,00,00,000 / 8.536
Annuity = 5,85,75,445
12. You can save Rs. 20000 a year for 5 years and Rs.
30000 a year thereafter for 10 years. What will these
savings cumulate to at end of 15 years if the rate of
interest is 10%?. There is no reinvestment of the initial
amount at the end of 5 years, it is held in
cash.

FVA = A x FVAFr,n [table factor]

The future value of annuity

= 20000 x FVAF @10% for 5 years + 30000 x FVAF @10% for 10 years
= 20000 x 6.1051 + 30000 x 15.9374
= 122102 + 478123
= 600225
 Componded
No. of Years
Yr Amt CF Value at the end
compounding
of 15 years
1 20000 4 1.4641 29282
2 20000 3 1.3310 26620
3 20000 2 1.2100 24200
4 20000 1 1.1000 22000
5 20000 0 1.0000 20000
20000 6.1051 122102
6 30000 9 2.3579 70738.43
7 30000 8 2.1436 64307.66
8 30000 7 1.9487 58461.51
9 30000 6 1.7716 53146.83
10 30000 5 1.6105 48315.30
11 30000 4 1.4641 43923.00
12 30000 3 1.3310 39930.00
13 30000 2 1.2100 36300.00
14 30000 1 1.1000 33000.00
15 30000 0 1.0000 30000.00
30000 15.9374 4,78,122.74
6,00,224.74
 PRESENT VALUE OF AN ANNUITY
An investor may have an Investment opportunity of receiving an ANNUITY (e.g. pension) – a
constant periodic amount – for a certain number of specified years. We use PV of annuity.

Many times investors want to know the PV which must be invested today in order to provide an
annuity for several future periods. We calculate PV of all future cash flows.
PVA = A* [{(1+r) ^n – 1} / [r *(1+r)^n]
PVA = A * {{1 – [1/ (1+r)n ]}/ r }

OR
PVA = A x PVIFAr,n
Example: let us suppose that a person receives an annuity of Rs. 5000 for four years. If the
rate of interest is 10 per cent, the PV of 5000 annuity is :

PV = A x 1-1/(1+r)^n)/r)
PV = 5000 x (1 – (1 / (1.1^4))) / 0.1
PV = 5000 x 3.170 = Rs. 15850
 13. What is the present value of a four year
annuity of Rs. 8,000 at 12% interest?

PVA = A x PVAFr,n
PVA = A x PVAF12%,4yrs
PV = 8000 x ((1-(1/1+0.12)^4)/0.12)
PV = 8000 x 3.0373

PV = 24298.
 14. Suppose you are determined that you can afford to pay Rs. 12000 per
month for 3 years towards a new Car. You call a finance company and learn
that the going rate of interest is 1.5 per cent per month for 36 months. How
much can you borrow?

To determine how much you can borrow, we have to calculate the Present Value
of Rs. 12000 per month for 36 months at 1.5 per cent per month. Since the loan
amounts are an annuity, the Present Value interest factor of annuity is:
PVA = A* [{(1+r) ^n – 1} / [r (1+r)^n]
= 12000 x [{ 1 + 0.015}^36 – 1} / [0.015*(1+0.015)^36]
= Rs. 3,31,928 This is the amount to be borrowed.

Using PVIFA table: we check 1.5 is between 1% and 2%, row 36 for 36
months: we take avearge of 30.108+25.489 = 27.8 approx, which would be
the factor and hence PVA = 12000*27.8 = 333600 approx

Alternatively, can check 332400/12000 = 27.7 Look for this factor in row 36 (it
will be considered as 36 months), it comes between 1% (30.108) and 2%
(25.969). The average of 30.108+ 25.969 = 28.03 approx, so we take the average
of 1%+2%=1.5% which tallies with the question.
Practice: You want to take up a trip to the moon which costs ₹ 10,00,000 – the
cost is expected to remain unchanged in nominal terms. You can save annually
₹ 50,000 to fulfill your desire. How long will you have to wait if your savings
earn an interest of 12 percent?
Practice: -You want to borrow ₹ 10,80,000 to buy a flat. You approach a
housing finance company which charges 12.5 percent interest. You can
pay ₹ 180,000 per year toward loan amortisation. What should be the
maturity period of the loan?
 An annuity is a stream of equal cash flows paid at
Annuity regular intervals.

Present Value of an Annuity (PVA) Future Value of an Annuity

(FVA)
1 1
=A* - 1+𝑟 𝑛 1
𝑟 𝑟 ∗ 1+𝑟 𝑛 =A* 𝑟
-
𝑟

𝐹𝑉𝐹 1
1 𝑃𝑉𝐹 =A* 𝑟
- 𝑟
=A*
𝑟
-𝑟

PVA = 1– FVA = FVF -

PVF
1
r
r
PVA = A * PVAF
FVA = A *
FVF= F.V Factor FVAF
PVF = P.V Factor
FVAF = F.V Annuity Factor
PVAF = P.V Annuity Factor
Ordinary Annuity V/S Annuity Due

– Ordinary annuity = cash flows at end of year

– Annuity due = cash flows at beginning of year

– Convert value of ordinary into Due

– FVA (due) = FVA (ordinary) x (1+r)

– PVA (due) = PVA (ordinary) x (1+r)

If nothing mentioned its always assume Ordinary Annuity

Example :Suppose you deposit Re 1 in a bank account at the
beginning of each year for 4 years to earn 6% p.a. interest? How
much will be the compound value at the end of 4 years.

Solution:
FVA due = 1*1.064 + 1*1.063 + 1*1.062 + 1*1.061
= 1.262 + 1.191 + 1.124 + 1.06 = Rs. 4.637

Or we can use
FVA due = FVA ordinary * (1+r)
= A { [ (1+r)^n - 1] / r} x (1+r)
= 1 { [ (1+0.06)^4 - 1] / 0.06} x (1+0.06) = 4.637
Example :Suppose you deposit Rs. 2,50,000 at the beginning of
every year for 2 years in a savings bank account at 6 per cent
compound interest, What is your money value at the end of
two years?

Solution:
FVA = A x [{(1+r)n – 1}/r}] x (1+r)
= 2,50,000 x (((1+0.06)^2)-1)/0.06 x 1.06
= 515000 x 1.06
= 5,45,900
or FVA = 545900
Application
of TVM
 Miscellaneous applications
1. Compounded Annual Growth Rate (CAGR)
FV = PV x FVF
2. Loan instalment annually = Loan / PVAF
PVA =A * PVAF
Where
PVA = Total Amount of Loan
A = Loan Instalment
PVAF = Present Value Annuity factor for n years, at r rate of interest p.a.
Hence A = PVA/PVAF
3. EMI (monthly) = Loan / PVAF (for n months, at r rate of interest per month)

4. Sinking Fund = FVA / FVAF (for n years, at r rate of interest p.a.)

FVA = A * FVAF
Where
FVA = Total Amount Required
A = Sinking Fund Amount p.a.
FVAF = Future Value Annuity factor for n years, at r rate of interest p.a.

Hence A = FVA / FVAF

 CAGR(Compounded annual Growth rate `
15. Mohan bought a share 15 years ago for Rs 10. It is now selling for Rs 27.60.
What is the compound growth rate in the price of the share?

Solution:
FV = PV x FVFr,n

Fv= PV (1+r)n
27.60 = 10 x FVFr,15years
FVFr,15years = 2.760
See in Table = 7%

In Excel
FV= 27.6
N= 15
PV = 10
16. The earnings of Fair growth Ltd were Rs 3 per share in year 1. It
increased over a 10 year period to Rs 4.02. Compute the rate of growth or
compound annual rate of growth of EPS.

Solution:
FV = PV x FVFr,n
4.02 = 3 x FVFr,10years
FVF = 1.34
r,10years
See in Table = 3%
 Loan Instalment (Annually)

17. Mr. Tarak plan to buy a house at Andheri (west) for Rs. 90,00,000. He
plans to borrow Rs. 60, 00,000 from HDFC Limited
to finance the purchase for 15 years. The rate of interest on such
loan is 12% per annum. Compute the annual instalment.
Solution:
Annual Loan Installment = Loan / PVAF 12%,15 years (table 4)
= 60,00,000 / (1-(1/1.12^15))/0.12

= 60,00,000 / 6.81086…

In Excel = 8,80,945

=PMT(12%,15,-60,00,000,0)
Loan Amortization schedule (EMI)
18. Sheetal Enterprises borrows Rs. 10,00,000 at an interest
rate of 15% per annum and loan is to be repaid in five equal
annual installments at the end of each year over the next five
years.
Calculate the annual installment paymentand its loan
amortization schedule.
Solution:
Annual Installment = Loan / PVAF 15%, 5 years.
= 10,00,000 / (1-(1/1.15^5))/0.15
A = 10,00,000 / 3.35215509813
= Rs. 298315.55 annual installment.
= Rs 298316 (approx)
Schedule.. Next slide..
Year Beginnin Annual Interest PrincipalRemainin
g g
–
Amount Instalment Repayment Amount
0
1 10,00,00 2,98,316 1,50,000 1,48,316 8,51,684
0
2 8,51,684 2,98,316 1,27,753 1,70,563 6,81,121
3 6,81,121 2,98,316 1,02,168 1,96,148 4,84,973
4 4,84,973 2,98,316 72,746 2,25,570 2,59,403
5 2,59,403 2,98,316 38,910 2,59,406 -3
(round off
Diff. Rs.3)
Practice :Your father deposits ₹ 300,000 on retirement in a bank which pays
10 percent annual interest. How much can be withdrawn annually for a period
of 10 years ?

Annual Installment = Loan / PVAF 10%, 10 years.

19. Krishna borrows Rs. 80,000 for a Sony music system at a
monthly interest of 1.25 per cent. The Loan is to be repaid in
12 equal installments, payable at end of each month. Prepare a
Loan amortization schedule.

The monthly installment A is obtained by solving the equation:

Monthly Loan Installment = Loan / PVAF1.25%,12

= 80,000 / {{1 – [1/ (1+r)n ]}/ r }

= 80,000/ {{1 – [1/ (1+ 0.0125)12 ]}/ 0.0125}
= 80000 /11.0793119768
= 7220.66498
= 7221
Month Beginning Monthly Interest Principal Remaining
Amount Instalment `@ 1.25 Repayment Amount
0
1 80,000 7,221 1,000 6,221 73,779
2 73,779 7,221 922 6,299 67,480
3 67,480 7,221 844 6,377 61,103
4 – 7,221 764 6,457 54,646
6 1,103
5 54,646 7,221 683 6,538 48,108
6 48,108 7,221 601 6,620 41,488
7 41,488 7,221 519 6,702 34,786
8 34,786 7,221 435 6,786 27,999
9 27,999 7,221 350 6,871 21,128
10 21,128 7,221 264 6,957 14,171
11 14,171 7,221 177 7,044 7,128
12 7,128 7,221 89 7,132 -4
Rounding
Off
Diff. Rs 4
 Sinking Fund
Is created out of fixed payments to accumulate to a future
sum after a specified period
Companies generally create Sinking fund to repay/retrieve the
Bonds/Debentures on Maturity
A = FV x [ r / {(1+r)^n – 1}]
Where A is Annual Amount to be kept aside in Sinking Fund
OR
FVA = A x FVAFr,n
Example: A company has issued debentures of Rs. 50,00,000 to be repaid
after 7 years. How much the company invest in sinking fund earning 12 per
cent in order to repay debentures?
Solution:
A = 50,00,000 x [ 0.12 / {(1+0.12)^7 – 1)}] A =
Rs. 495,588.6795

A = Rs 4,95,589

OR
FV = A x FVAF
12%,7 years
50,00,000 = A x (((1+0.12)^7)-1) / 0.12
A = 50,00,000 / 10.08901
A = 4,95,588.7
 Sinking Fund
20. A company wants to buy an asset worth Rs. 100,000 at the end
of 10 years. Find out the annual payment required, if savings can
earn an interest of 12 per cent
Solution:
A = FV x [r/{(1+r)^n – 1)}]
FV = A / [r/{(1+r)^n – 1)}]
100,000 = A x [ 0.12 / {(1+0.12)^10 – 1)}]
A = Rs. 5699

OR
FV = A x FVAF .
12%,10 years

100,000 = A x 17.549

A = 100,000 / 17.549 = Rs. 5699

 Practice : How much amount is required to be invested every year so
as to accumulate ₹ 300000 at the end of 10 years if interest is
compounded annually at 10%?

FV = A x FVAF
3,00,000 = A x [ {(1+0.1)10 – 1}/0.1 ]
3,00,000 = A x 15.9374
A = 300,000 / 15.9374
A = 18,824

FVA
Perpetuity
 Perpetuity
A perpetuity is a stream of equal cash flows that occur at regular
intervals and last forever.

The oldest perpetuities that are still making interest payments were issued in
1624 by the Hoogheemraadschap Lekdijk Bovendams, a seventeenth-century
Dutch water board responsible for upkeep of the local dikes. On its issue date
in 1648, this bond originally paid interest in Carolus guilders. Over the next
355 years, the currency of payment changed to Flemish pounds, Dutch
guilders, and most recently euros. Currently, the bond pays interest of €11.34
annually.
Perpetuities

– Is a stream of equal cash flows that occur at regular intervals and last forever.
One example is the British government bon called CONSOL (or perpetual bond).
Consol bonds promise the owner a fixed cash flow every year, forever. The first
cash flow will normally arrive at the end of a year (ordinary annuity).
– PV = C/(1+r) + C/(1+r)^2 +C/(1+r)^3 + …… = Σ Cn/(1+r)^n, where n = 1 to α
(infinity)

– Since it is infinite we will not be able to calculate the value of ‘n’.

– However , using the LAW OF ONE PRICE, we calculate our own value of
perpetuity , wherein we want to at least recover out original cost/investment
and hence, the value of the perpetuity must be the same as the cost we
incurred to create the perpetuity.

– The LAW OF ONE PRICE states that generally, the same good must have the
same price in every market.
 Perpetuity
– For example, say you invest $100 in a bank paying $5 interest in a
perpetuity. You withdraw $5 in year 1 and reinvest $100 back. In
second year, you will again withdraw $5 and reinvest $100 and
so on. You are creating a perpetuity of receiving $5 every year.

– Now lets generalize the argument. Suppose we invest an amount P

in a bank, every year we can withdraw C = r x P, leaving the
principal, P, in bank. The present value of receiving C in perpetuity
is therefore the upfront cost P = C / r, therefore,
– PV of (C in perpetuity) = C / r
– By depositing C / r today, we can withdraw interest of C /r x r = C
each period in perpetuity
Example : Ramesh wants to retire and receive ₹3,000 a month. He wants to pass this
monthly payment to future generations after his death. He can earn an interest of 8%
compounded annually. How much will he need to set aside to achieve his perpetuity goal?

– PVA = A / r
– A = the payment or receipt each period
– r = the interest rate per payment or receipt period
A = 3000
r = .08/12 = .00667
= 3,000/.00667
= 4,49,775
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