Page 35 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 2: Time Value of Money

2.7 Keywords Notes

Annuity: It is a stream of equal annual cash flows.
Cash Flow: It is the movement of cash into or out of a business, a project, or a financial product.
It is usually measured during a specified, finite period of time
Compound Interest: When interest is added to the principal, so that from that moment on, the
interest that has been added also itself earns interest.

Compound Value: The interest earned on the initial principal becomes a part of the principal at
the end of a compounding period.
Interest: It is a fee paid on borrowed assets. It is the price paid for the use of borrowed money.

Present Value: In case of present value concept, we estimate the present worth of a future
payment/instalment or series of payment adjusted for the time value of money.
Time Value of Money: Time value of money is that the value of money changes over a period of
time.

2.8 Review Questions

1. “Cash flows of two years in absolute terms are uncomparable” Give reasons in support of
your answer.

2. Define the following terms and phrases:
(a) Compound sum of an annuity
(b) Present value of a future sum
(c) Present value of an annuity
(d) Annuity

(e) Discount rate
3. What happens to the effective rate of interest as the frequency of compounding is increased?
4. As a financial consultant, will you advise your client to have term deposit in a commercial
bank, which pays 8% interest compounded semi-annually or 8% interest compounded
annually? Why?
5. What effects do (i) increasing rate of interest and (2) increasing time periods have on the
(a) present value of a future sum and (b) future value of the present sum? Why?

6. Can annuity tables be used for all types of cash flows?
7. For a given interest rate and a given number of years, is the factor for the sum of an
annuity larger or smaller than the interest factor for the present value of the annuity?
8. Explain the mechanics of calculating the present value of a mixed stream that includes an
annuity.
9. A limited company borrows from a commercial bank 10,00,000 at 12% rate of interest to
be paid in equal end-of-year installments. What would the size of the instalment be?
Assume the repayment period is 5 years.
10. If ABC company expects cash inflows from its investment proposal it has undertaken in
time zero period, 2,00,000 and 1,50,000 for the first two years respectively and then
expects annuity payment of 1,00,000 for next eight years, what would be the present
value of cash inflows, assuming 10% rate of interest?

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