Time value money - This chapter is first chapter when start studying financial management. Time value of money • Suppose you are given a choice to receive $5000, today or after a year what will you prefer? Obviously, you will opt to receive it today$ 5000 because you can earn the interest in the year Suppose interest rate is @10% Per annum Now (0 Year (Today)) 1 Year $ 5000 (PV) 5000+ 5000*0.10 =5,500 (FV) Time value of money Difference b/w present value (PV) and Future Value is time value money (FV). i.e (Interest rate) Time value money= 5500-5000= 500 =500 Types of Interest 1) Simple Interest (Legal interest) 2) Compound Interest (XXXXX) Mostly which we use in day-to-day life? Simple Interest rate Principal=$5000 1 Year 10% For Interest =5000*.10*1 =500 2nd Year = 5000*.10*1 =500 2. Compound Interest, compounding is annually Principal =5000 1 Year = 500 2nd year= (5000+500) *.10*1 =550 3rd year= Principal=5000+(Ist year interest)500+ (2nd yrs Interest) 550 Principal=6050 Interest=6050*10*1 =605 Suppose Every year bank is paying the interest then how we will calculate the interest rate Interest rate 10%, Principal is $5000 Principal =5000 1 Year Interest = 500 (which paid by bank) 2nd year= (5000) *.10*1 =500 1.Simple Interest Every period interest calculated on initial Principal amount is known as Simple interest. Now 1 Yr 2nd Yr $ 5,000 =$5,000*0.01*1 =$5,000*0.01 =500 =500 Simple interest amount every period will be the same. Mostly use in legal cost Compound Interest Interest calculated on previous period interest plus(+) Principal is known as compound interest. Now 1 Yr 2nd Yr $ 5,000 =$5,000*0.01 =$5,500*0.01 =(5000+500) =500 =550 =(5000+500+550)*0.10 Compound interest every period will be different. What will happen if bank will pay 500 at end of year end? =5000*0.01 Compounding in yearly basis - Monthly (10%/12) - Quarterly (.10/4) - Daily (0.10/365(360)) - Semi-annual (0.10*6/12)