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Apna Sapna Money-Money
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I. M. Pandey, Financial Management, 9th ed., Vikas.
Kaun Banega Crorepati
Concepts of
Time Value of
Money
Business Activities
 Production
 Marketing
 Finance
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I. M. Pandey, Financial Management, 9th ed., Vikas.
Meaning
 Financial management is a systematic
process that provides the necessary financial
information to help a business produce and
distribute goods and services in a way that
will make the most profit. It also provides
feedback about how well the organization is
doing.
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I. M. Pandey, Financial Management, 9th ed., Vikas.
Chapter Objectives
 Understand what gives money its time value.
 Explain the methods of calculating present
and future values.
 Highlight the use of present value technique
(discounting) in financial decisions.
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Our Strategy for achieving these
Objectives?
 Concepts, Cases and Class Discussion
 Punctuality, Participation and Preparation
(Its compulsory to bring your own calculators, Pen,
Stationary, Registers, Prescribed Book, Printouts of
the Intranet documents- Otherwise necessary
disciplinary action will be taken)




Judgment challenge
Learning to communicate ideas
Learning from each other
Learning through discovery
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I. M. Pandey, Financial Management, 9th ed., Vikas.
Finance Functions
 Investment or Long Term Asset Mix Decision
 Financing or Capital Mix Decision
 Dividend or Profit Allocation Decision
 Liquidity or Short Term Asset Mix Decision
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I. M. Pandey, Financial Management, 9th ed., Vikas.
Financial accounting and Financial
Management
 Financial accounting gives the financial status
of the company to people outside the
company. It is recording and reporting the
activities and events that lead to cash inflow
and outflow.
 Financial management means efficiently
managing the various resources of the
company.
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I. M. Pandey, Financial Management, 9th ed., Vikas.
Managers Versus Shareholders’
Goals
 A company has stakeholders such as employees, debt-holders,
consumers, suppliers, government and society.
 Managers may perceive their role as reconciling conflicting
objectives of stakeholders. This stakeholders’ view of managers’
role may compromise with the objective of SWM.
 Managers may pursue their own personal goals at the cost of
shareholders, or may play safe and create satisfactory wealth
for shareholders than the maximum.
 Managers may avoid taking high investment and financing risks
that may otherwise be needed to maximize shareholders’
wealth. Such “satisfying” behaviour of managers will frustrate
the objective of SWM as a normative guide.
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I. M. Pandey, Financial Management, 9th ed., Vikas.
Financial Goals and Firm’s Mission
and Objectives
 Firms’ primary objective is maximizing the welfare of
owners, but, in operational terms, they focus on the
satisfaction of its customers through the production of
goods and services needed by them
 Firms state their vision, mission and values in broad
terms
 Wealth maximization is more appropriately a decision
criterion, rather than an objective or a goal.
 Goals or objectives are missions or basic purposes of a
firm’s existence
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I. M. Pandey, Financial Management, 9th ed., Vikas.
Financial Goals and Firm’s Mission
and Objectives
 The shareholders’ wealth maximization is the
second-level criterion ensuring that the
decision meets the minimum standard of the
economic performance.
 In the final decision-making, the judgement of
management plays the crucial role. The wealth
maximization criterion would simply indicate
whether an action is economically viable or not.
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I. M. Pandey, Financial Management, 9th ed., Vikas.
Time Preference for Money
 Time preference for money is an
individual’s preference for possession of a
given amount of money now, rather than the
same amount at some future time.
 Three reasons may be attributed to the
individual’s time preference for money:



risk
preference for consumption
investment opportunities
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Required Rate of Return
 The time preference for money is generally
expressed by an interest rate. This rate will be
positive even in the absence of any risk. It may
be therefore called the risk-free rate.
 An investor requires compensation for assuming
risk, which is called risk premium.
 The investor’s required rate of return is:
Risk-free rate + Risk premium.
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Time Value Adjustment
 Two most common methods of adjusting cash
flows for time value of money:


Compounding—the process of calculating future
values of cash flows and
Discounting—the process of calculating present
values of cash flows.
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Future Value
 Compounding is the process of finding the future
values of cash flows by applying the concept of
compound interest.
 Compound interest is the interest that is received on
the original amount (principal) as well as on any
interest earned but not withdrawn during earlier
periods.
 Simple interest is the interest that is calculated only
on the original amount (principal), and thus, no
compounding of interest takes place.
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Future Value
 The general form of equation for calculating
the future value of a lump sum after n periods
may, therefore, be written as follows:
Fn  P(1  i ) n
 The term (1 + i)n is the compound value
factor (CVF) of a lump sum of Re 1, and it
always has a value greater than 1 for positive
i, indicating that CVF increases as i and n
increase.
Fn =P  CVFn,i
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Example
 If you deposited Rs 55,650 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 which is
4.046. Multiplying 4.046 by Rs 55,650, we get
Rs 225,159.90 as the compound value:
FV  55,650 × CVF10, 0.12  55,650  4.046  Rs 225,159.90
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Present Value
 Present value of a future cash flow (inflow or
outflow) is the amount of current cash that is
of equivalent value to the decision-maker.
 Discounting is the process of determining
present value of a series of future cash flows.
 The interest rate used for discounting cash
flows is also called the discount rate.
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Present Value of a Single Cash Flow
 The following general formula can be employed to
calculate the present value of a lump sum to be
received after some future periods:
P
Fn
n



F
(1

i
)
n 
n
(1  i )
 The term in parentheses is the discount factor or
present value factor (PVF), and it is always less
than 1.0 for positive i, indicating that a future amount
has a smaller present value.
PV  Fn  PVFn,i
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Example
 Suppose that an investor wants to find out
the present value of Rs 50,000 to be
received after 15 years. Her interest rate is
9 per cent. First, we will find out the present
value factor, which is 0.275. Multiplying
0.275 by Rs 50,000, we obtain Rs 13,750 as
the present value:
PV = 50,000  PVF15, 0.09 = 50,000  0.275 = Rs 13,750
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
21
Exercises
What's the present value of:
A. $10000000 in 1 years at 16 percent?
B $9,000 in 2 years at 8 percent?
C $20,000 in 5 years at 10 percent?
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Future Value of an Annuity
 Annuity is a fixed payment (or receipt) each
year for a specified number of years. If you rent
a flat and promise to make a series of
payments over an agreed period, you have
created an annuity.
 (1  i ) n  1 
Fn  A 

i


 The term within brackets is the compound
value factor for an annuity of Re 1, which we
shall refer as CVFA.
Fn =A CVFA n, i
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Example
 Suppose that a firm deposits Rs 5,000 at the
end of each year for four years at 6 per cent
rate of interest. How much would this annuity
accumulate at the end of the fourth year? We
first find CVFA which is 4.3746. If we multiply
4.375 by Rs 5,000, we obtain a compound
value of Rs 21,875:
F4  5,000(CVFA4, 0.06 )  5,000  4.3746  Rs 21,873
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Exercises
If you invest $2,000 a year in a retirement
account, how much would you have:
a.
In 5 years at 6 percent?
b.
In 20 years at 10 percent?
c.
In 40 years at 12 percent?
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Present Value of an Annuity
 The computation of the present value of an
annuity can be written in the following general
form:
1
1 
P  A 

n
 i i 1  i  
 The term within parentheses is the present
value factor of an annuity of Re 1, which we
would call PVFA, and it is a sum of singlepayment present value factors.
P = A × PVAFn, i
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Exercise
John Smith will receive $8,500 a year for the
next 15 years from her trust. If a 7 percent
interest rate is applied, what is the current
value of the future payments?
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Present Value of an Uneven
Periodic Sum
 Investments made by of a firm do not
frequently yield constant periodic cash flows
(annuity). In most instances the firm receives
a stream of uneven cash flows. Thus the
present value factors for an annuity cannot be
used. The procedure is to calculate the
present value of each cash flow and
aggregate all present values.
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Present Value of Perpetuity
 Perpetuity is an annuity that occurs
indefinitely. Perpetuities are not very common
in financial decision-making:
Present value of a perpetuity 
Perpetuity
Interest rate
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Value of an Annuity Due
 Annuity due is a series of fixed receipts or
payments starting at the beginning of each
period for a specified number of periods.
 Future Value of an Annuity Due
Fn = A  CVFA n, i × (1  i)
 Present Value of an Annuity Due
P = A × PVFA n, i × (1 + i)
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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Assignment
 Q1,2,3,7,8 of Chapter-2 of Financial
Management by I.M. Pandey (IXth Edition),
Vikas publishing house
 Answers in A4 page
 Individual submission
Financial Management, Ninth Edition © I M Pandey
Vikas Publishing House Pvt. Ltd.
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