Topic 5: Time Value of Money

Food of the Mind

Learning Objectives

After successful completion of this topic, you should be able to:

 Explain how the time value of money works and its importance;
 Calculate the present value and future vale of lump sums
 Identify the different types of annuities and calculate the present value and
future value of both an ordinary annuity and an annuity due

Activating Prior Knowledge

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Answers:

Financial Management Module 1

1. Risk, Rate & Return
2. Time Value of Money
(Sana Quiz ka na lang….50 points!)

Presentation of Contents

 TIME LINE
 It is an important tool used in time value analysis.
 It is a graphical representation used to show the timing of cash flows.
 As an illustration, consider the following diagram, where Present Value
(PV) represents Php 100 that is on hand today and Future Value (FV) is
the value that will be in the account on the future date.

Periods 0 5% 1 2 3

Cash PV = Php100 FV = ?

o The intervals from 0 to 1, 1 to 2 and 2 to 3 are time periods such as

years or months. Time 0 is today and it is the beginning of Period 1;
Time 1 is one period from today, and it is both the end of Period 1
and the beginning of Period 2; and so forth. Although the periods
are often years, periods can also be quarters or months or even
days.
o Note that each tick mark corresponds to both the end of one period
and the beginning of the next one. Thus, if the periods are years, the
tick mark at Time 2 represents the end of Year 2 and the beginning
of Year 3.
o Cash flows are shown directly below the tick marks and the
relevant interest rate is shown just above the timeline. Unknown
cash flows, which you are trying to find, are indicated by question
marks.
o Here the interest rate is 5%; a single cash outflow, Php 100, is
invested at Time 0; and the Time 3 value is an unknown inflow. In
this example, cash flows occur only at Times 0 and 3 with no flows
at Times 1 or 2.

 OVERVIEW OF MONEY’S TIME VALUE

 Situations that Financial Managers are tasked to do using their skill
in TVMA:
o Evaluating new project proposals which would entail cash inflow as
well as outflow
o Managing and valuing cash funds like sinking funds and bond
redemption funds, pension funds and employee benefits
o Managing and valuing receivables specifically for banks having

Financial Management Module 2

 long-term loan receivables handle
o Managing and valuing long-term obligations like bond payable
where refunding a bond issued is concerned.

 TIME VALUE OF MONEY (TVM)

o It is the idea that money that is available at the present time is worth
more than the same amount in the future, due to its potential
earning capacity.
o This core principle of finance holds that provided money can earn
interest, any amount of money is worth more the sooner it is
received.
o One of the most fundamental concepts in finance is that money has
a time value attached to it. In simpler terms, it would be safe to say
that a dollar was worth more yesterday than today and a dollar
today is worth more than a dollar tomorrow.

 FUTURE VALUE OF ONE AMOUNT

 COMPOUNDING – the arithmetic process of determining the final
value of a cash flow or series of cash flows when compound interest is
applied.
 FUTURE VALUE (FV) – the amount to which a cash flow or series of
cash flows will grow over a given period of time when compounded at a
given interest rate.
 PRESENT VALUE (PV) – the value today of a future cash flow or
series of cash flows
 FUTURE VALUE FACTOR – is actually the ratio or the relationship
of the future value of an amount to its present value.
 PRESENT VALUE FACTOR – is the ratio or relationship of the
present value of an amount to its future value.
 When a company is to receive or pay something ONCE in the future,
the future value of a single amount or the future value of Php 1.0 is
computed.
 The basic formula to compute future value is:

FVn = PV (1 + i)n
where: FV is the future value of an amount
n is the number of periods (n=tm)
PV is the present value of an amount
i is the periodic rate (i=r/m)
m is the conversion period (1=annually; 2-semiannually;
4-quarterly; 12-monthly)

Financial Management Module 3

  EXAMPLE:
o Assume that Juan plans to deposit Php 10,000 in a bank that
pays a guaranteed 5% interest each year. How much would Juan
have at the end of Year 3?
o SOLUTION: FVn = PV (1 + i)n
= 10,000 (1 + 0.05)3
= 11,576.25

 FUTURE VALUE OF AN ANNUITY

 Definitions of Terms
o ANNUITY – is a sequence of periodic payments made at a regular
interval of time in order to pay a loan or create a fund.
o ANNUITY CERTAIN – is an annuity in which payments begin
and end on a definite or fixed date.
o ANNUITY UNCERTAIN – is an annuity whose payment
beginning and termination is indefinite for it is dependent on some
event that cannot be determined accurately.
o SIMPLE ANNUITY - payment interval is equal to conversion
period.
o GENERAL ANNUITY – payment interval is not equal to
conversion period.
o ORDINARY ANNUITY – is an annuity whose periodic payments
are scheduled at the end of each payment interval.

 Future Value of an Ordinary Annuity

o We compute the future value of several amounts or future value of
annuity if the company receives or pays a series of equal amounts.
o The formula to be used is:
FV Annuity = Amount periodically received or paid x
FV Annuity Factor

(1+𝑖)𝑛 −1
S =Rx⌈ ⌉
𝑖
where: S = amount of an ordinary annuity at the end on periods
R = periodic payment
n = number of periods or payments
i = rate per conversion period.

EXAMPLE: Assume that Enzo Company is to make annual

investment of Php 200,000 for four years. The interest for this
investment was pegged at 9%. The investment is made every year
end. What is the value of this annuity?

Financial Management Module 4

 (1+𝑖)𝑛 −1
S =Rx⌈ ⌉
𝑖
(1+0.09)4 −1
= 200000 x ⌈ ⌉
0.09
= 914,625.80

 Future Value of an Annuity Due

o If the investment is done at an earlier date (beginning of the year),
naturally more interest would be earned.
o Therefore, the future value of annuity due is bigger in comparison
to the future value of ordinary annuity.

o The formula to be used is:

FV Annuity Due = Amount periodically received or paid x FV
Annuity Factor
(𝟏+𝒊)𝒏+𝟏 −𝟏
S (due) = R x ⌈ − 𝟏⌉
𝒊

EXAMPLE: Let us use the data of Enzo Company. Assume that

Enzo is to make annual investments of Php 200,000 for four years.
The interest for this investment was pegged at 9%. The investment
is made at the beginning of each year. What is the future value of
this annuity due?
(1+𝑖)𝑛+1 −1
S (due) = R x ⌈ − 1⌉
𝑖
(1+0.09)4+1 −1
= 200000 x ⌈ − 1⌉
0.09
= 996,942.12

 PRESENT VALUE W/ A SINGLE AMOUNT

 DISCOUNTING – the process of finding the present value of a cash
flow or a series of cash flows. It is the reverse of compounding.

 The basic formula to compute present value is:

PVn = FV (1 + i)-n

EXAMPLE: Discount Php 75,000 for 2 years at 8% converted

monthly.

i = r/m n = t(m)
= 0.08/12 = 2 x 12
= 0.006667 = 24

PVn = FV (1 + i)-n
= 75,000 (1+0.006667) -24
= 63,944.22

Financial Management Module 5

 PRESENT VALUE W/ SEVERAL AMOUNTS
 Present Value of an Ordinary Annuity – is the sum of the present
values of all the payments, each payment being discounted at the given
rate of interest from the time it is made back to the beginning of the
term.
o The present value of an ordinary annuity for n payment periods
is given by the formula:
𝟏 − (𝟏+𝒊)−𝒏
A=R⌈ ⌉
𝒊
where: A = present value of an ordinary annuity for n periods
R = periodic payment or rent
n = number of periods or payments
i = rate of interest per period

Example: Find the present value of an ordinary annuity of Php 750

per month for 8 years if money is worth 7% compounded monthly.
R = ₱750, n = 12(8) = 96, and i = 0.07/12 = 0.005833

𝟏 − (𝟏+𝒊)−𝒏
A=R⌈ ⌉
𝒊
1 − (1+0.005833)−96
= 750 ⌈ ⌉
0.005833
= ₱55,010.68

o Cash Value = Down payment + Present Value

 Present Value of an Annuity Due

o The present value of an ordinary annuity for n payment periods
is given by the formula:
𝟏 − (𝟏+𝒊)𝟏−𝒏
A=R⌈ + 𝟏⌉
𝒊

EXAMPLES:
Find the present value of a series of periodic payments of Php
5,000 each, made at the beginning of every month for 3.5 years,
if money is worth 9%, compounded monthly.

i = r/m = 0.09/12 = 0.0075

n = t(m) = 3.5 x 12 = 42

𝟏 − (𝟏+𝒊)𝟏−𝒏
A=R⌈ + 𝟏⌉
𝒊
𝟏 − (𝟏+𝟎.𝟎𝟎𝟕𝟓)𝟏−𝟒𝟐
= 5000 ⌈ + 𝟏⌉
𝟎.𝟎𝟎𝟕𝟓
= 180,915.3

Financial Management Module 6

 Application

1. ESSAY. Explain why this statement is true: A dollar in hand today is

worth more than a dollar to be received next year.
2. Problem Solving. Analyze and solve the following problems by showing
your solutions in good form.
a. Accumulate ₱25,000 for 5 years at 8%, compounded quarterly.
b. How much must be invested today at 10%, compounded semiannually
for 25 years to produce ₱1,500,000?
c. Manuel dela Cruz purchased a lot and agreed to pay ₱1,600 a month
for 15 years. If money is worth 9%, compounded monthly, what single
payment at the end of 15 years would be equivalent to his total
monthly payments?
d. A man purchases a house and lot and agrees to pay ₱850,000 cash and
₱25,000 at the end of each month for 20 years. What is the cash value
of the house and lot if money is worth 9% compounded monthly?
e. A man deposits ₱5,600 at the beginning of each 3 months in a bank
whih pays interest at a rate of 10%, converted quarterly. How much
will be in his account after 7.5 years?
f. The periodic payments of an annuity due are ₱14,500 for 12 years. If
money is worth 8%, compounded semiannually, what is the present
value of the annuity?

Feedback

Compute the following problems: (30 points) To be submitted ‘till 12 midnight.

1. How much will Php 15,000 amount to in 4 years and 6 months at 7%
compounded semiannually?
2. Find the present value of Php 120,000 due in 3 years and 9 months if money
is worth 10%, compounded quarterly.
3. To replace his sala set, Teddy Palomo made quarterly payments of Php
1,800 each in a fund that paid 12%, compounded quarterly. How much was
in the fund at the end of 2.5 years?
4. A contract calls for 20 semiannual payments of Php 75,000 each. Find the
present value of the contract if money is worth 7.2% compounded
semiannually.
5. An annuity contract provides for the payment of Php 58,750 on the first of
each quarter for 8 years. If money earns interest at 10%, compounded
quarterly, what is the amount of annuity at the end of the term?
6. What is the present value of an annuity due in which a payment of Php 7,600
us to be made at the beginning of each month for 5 years if money is worth
9% compounded monthly?

Financial Management Module 7

SUMMARY
 Time value of money is the idea that money that is available at the
present time is worth more than the same amount in the future, due to
its potential earning capacity.
 Future value is the amount to which a cash flow or series of cash flows
will grow over a given period of time when compounded at a given
interest rate. On the other hand, present value is the value today of a
future cash flow or series of cash flows.
 Annuity is a sequence of periodic payments made at a regular interval
of time in order to pay a loan or create a fund. It is classified either
annuity certain or annuity uncertain; simple annuity or general annuity;
and ordinary annuity, annuity due or deferred annuity.

REFERENCES

Printed Sources
 Brigham, Eugene F. et. al. (2019). Essentials of Financial
Management. Fourth Edition. Cengage Learning Asia Pte Ltd.
 Van Horne, James C. and John M. Wachowicz, Jr. (2009).
Fundamentals of Financial Management. Pearson Eduction
Limited.
 Bautista, Leodegario SM. et al Mathematics of Investment 3rd
Edition C&E Publishing, Inc. 2012
 Kolb, Burton A. & DeMong, Richard F. Principles of Financial
Management Business Publications, Inc. 1988

Financial Management Module 8