I was going through d chapter - TIME VALUE OF MONEY of FM- IPCC. Can anybody plz tell me when to use d formula of future value of annuty and when to use present value of annuty.
Am Really confused
Plz help me out guyz
19 Replies
Faiz Ahmed
( Article Trainee)
(1731 Points)
Replied 19 September 2010
See when question is asked to find present value of any future cash inflow/outflow, use present value of annuity. Suppose next year you will get Rs1000. Presently its value will be less due to inflation factor so we calculate its present value to get intrinsic value of Rs 1000. Assuming 10% return PV factor for 1st year will be 0.909, so Present value of Rs 1000 will be Rs 909.
In reverse of the above case, we use Future value of annuity.
Do only study material problems for this chapter. Practice 2 times you will get the grip.
Karthik
(student)
(147 Points)
Replied 19 September 2010
@ faiz
Inflation factor is not considered while calculating the present value.
what is considered is the risk free interest rate.
for example, if we have rs 10 now and the risk free rate is 10%,
the future value of Rs 10 is 11 (if we have deposited that rs 10 in a bank account of 10% interest. we will get Rs 11).
Inversly, the present value of Rs11 recieved at the end of year 1 will be Rs 10.
Faiz Ahmed
( Article Trainee)
(1731 Points)
Replied 19 September 2010
@ Karthik,
In my answer i have told about the reason for such happening. Inflation is the cause and risk free interest rate is the effect.
Still i would like you to clear me about your point with better clarity.
Karthik
(student)
(147 Points)
Replied 19 September 2010
Dont confuse the inflation rate with the risk free rate..
See this example,
Assume that there is no inflation
you have Rs 100 in your hand.
Assume govt bond rate is 10% (Assumed as risk free)
You will invest this Rs 100 in the Govt Bond.
After one year you will get the princple (Rs100)+ interest (Rs100 * 10%)
Rs 110 in Total.
Therefore, the future value of Rs 100 after one year at a risk free rate of Rs 10 is Rs 110.
Inverse the above example..
You have no money in hand.
You will get Rs 110 after one year. Which means its present value is Rs 100.(if u get Rs 100 now u cud have invested it and get Rs110 in one year time)..
Ankit
(ca final)
(287 Points)
Replied 19 September 2010
But guyz my doubts r not clear
plz tell me ven 2 use d future value of annuty formula n ven 2 use present annuty formula
Faiz Ahmed
( Article Trainee)
(1731 Points)
Replied 19 September 2010
@ Ankit,
I have explained the logic when to apply. It will be given in your question what to calculate. Just think over it. You are confusing yourself unnecessarily for such a simple topic. Kindly elaborate your confusion with examples so that we can clear the exact confusion.
@ Karthik,
You have again said same thing in a different language. My question to you, how interest rates are fixed? Is it comes from imaginative thinking or there is some logic behind those numbers. As said earlier Inflation and other factors are causes and Interest rates is effect. Interest rates cannot come simply without any logic.
Hope you all understood.
Ankit
(ca final)
(287 Points)
Replied 19 September 2010
Q Calculate the amount to be invested at the end of each year for a period of 6 years at a rate of 6% p.a. in order to acxcumulate 1000 at d end of 6 years
Q If the interest rate is 15 % p.a. wat is d amount 2 b invested today to earn an annuty of 5 years commencing from d end of 1st year
WHT S D DIFFERENCE BTN D 2 QS
??
WR TO USE PRESENT 1 N WERE TO USE FUTURE ONE????
Ankur A Mehta
(CA)
(375 Points)
Replied 19 September 2010
@ ankit
in your first ques use future value and in 2nd present value ... pls understand wat ques is saying ... ques is clear abt this issue
Faiz Ahmed
( Article Trainee)
(1731 Points)
Replied 19 September 2010
| Originally posted by : Ankur | ||
 |
@ ankit in your first ques use future value and in 2nd present value ... pls understand wat ques is saying ... ques is clear abt this issue |
 |
Agreed
Ankit
(ca final)
(287 Points)
Replied 19 September 2010
ANKUR ...U R RITE BUT TELL ME Y?????????????????????
Reena Verma
(CA Finalist)
(417 Points)
Replied 19 September 2010
FOR INVESTMENT ORIENTED PLANS ,COMPOUNDING (FUTURE VALUE) FORMULA WILL BE USED WHILE FOR LOAN ORIENTED PLANS DISCOUNTING ( PRESENT VALUE) FORMULA WILL BE USED.
HOPE U GOT UR ANS NOW.....
Faiz Ahmed
( Article Trainee)
(1731 Points)
Replied 19 September 2010
| Originally posted by : Reena Verma | ||
|
|
FOR INVESTMENT ORIENTED PLANS ,COMPOUNDING (FUTURE VALUE) FORMULA WILL BE USED WHILE FOR LOAN ORIENTED PLANS DISCOUNTING ( PRESENT VALUE) FORMULA WILL BE USED. HOPE U GOT UR ANS NOW..... |
|
Your logic is not matching with the question and its answers. Question has investment plan in both cases.
Faiz Ahmed
( Article Trainee)
(1731 Points)
Replied 19 September 2010
| Originally posted by : Ankit Mehta | ||
|
|
Q Calculate the amount to be invested at the end of each year for a period of 6 years at a rate of 6% p.a. in order to acxcumulate 1000 at d end of 6 years Q If the interest rate is 15 % p.a. wat is d amount 2 b invested today to earn an annuty of 5 years commencing from d end of 1st year WHT S D DIFFERENCE BTN D 2 QS ?? WR TO USE PRESENT 1 N WERE TO USE FUTURE ONE???? |
|
In 1st question you want to accumulate Rs 1000 at the end of 6 yrs. It means you want value(intrinsic) at the end of 6 yrs. The value of future flow is different from present one. For this you decided to invest from now. When you decided to invest now, you expect the the present investment made in instalments to match with value at the end of 6yrs. So we use Future Value.
In 2nd question, you want to invest at todays rate i.e. present value. Hence we use Present Value.
Savita
(CA Final)
(141 Points)
Replied 19 September 2010
Time value of money means that, worth of a rupee received today is different from the worth of the money to be recieved in future. Difference in value over the time may be due to any reason like inflation, risk, opportunity cost, etc.
Before analysing remember that either the Ques. is asking about
1.'COMPOUNDING' the present money to a future date i.e. finding out the future value of present money. OR
2.'DISCOUNTING' future money to the present date i.e. finding out Present vale of future money.
These terms may not be mentioned in the Ques. directly, but once you are clear about the above terms you can easily understand its language.
One more thing which would be there in the Ques. is, depending upon the above scenario:
1. If it is about finding the PV then Future expected amount, time & rate of interest will be given to you in the Ques
2. Similarly, if it is about finding the FV then Present amount that is being invested, time & rate of interest will be given to you in the Ques
This way you can solve the questions. I hope I have cleared your doubt.
In case of any further doubt u can post.
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