TIME VALUE OF

MONEY
Annalyn M. Caymo
 OBJECTIVEs:

Understand what gives money its time value.

30%
Explain the methods of calculating present and future values.

Highlight the use of present value technique (discounting) in

financial decisions.

Introduce the concept of internal rate of return.

What is the Time Value of Money
(TVM)?

The time value of money (TVM) is the

concept that a sum of money is worth 30%
more now than the same sum will be at a
future date due to its earnings potential in
the interim.

This concept is fundamental to

financial
literacy and applies to your savings,
investments and purchasing power
 What is the Time Value of Money
(TVM)?

30%
The idea that money at the present time is worth more than
the same amount in future due to its potential earning
capacity.

• The time value of money says that a peso received TODAY is

worth MORE than a peso received TOMORROW.

• This is true because a peso received today can be INVESTED

to earn interest
 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
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.
 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.
 Present Value (PV)
is the current value of a future sum of money or stream
of
cash flows given a specified rate of return

Free cash flow (FCF) is the cash generated by a company

from its normal business operations after subtracting any
money spent on capital expenditures (CapEx).

Capital expenditures (CapEx) are funds used by a company to

acquire, upgrade, and maintain physical assets such as
property, plants, buildings, technology, or equipment.
 Present Value (PV)
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.
 Future Value (FV)
is the value of a current asset at a future
date based on an assumed rate of growth.

Knowing the future value enables

investors to make sound investment
decisions based on their anticipated needs.

However, external economic factors, such

as inflation, can adversely affect the future
value of the asset by eroding its value.
Future Value (FV) vs. Present Value (PV)

The concept of future value is often closely tied to

the concept of present value.
Whereas future value
calculations attempt to figure out the value of
something in the future, present value attempts to
figure out what something in the future will be
worth today.
PV vs. FV Exercises
At the beginning of the year, BRB invested
P150,000 in a certificate of deposit for one
year at 12% interest per annum. What will be
the value of the said investment at the end of
the year?

PV FV
PV vs. FV Exercises
At the beginning of the year, BRB invested
P150,000 in a certificate of deposit for one
year at 12% interest per annum. What will be
the value of the said investment at the end of
the year?
n
FV= P (1 + i) or 𝐹𝑉𝑛 = 𝑃𝑜 + 𝑆𝐼 = 𝑃𝑜 + 𝑃𝑜(𝑖)(𝑛)
𝐹𝑉𝑛 = 𝑃𝑜[1 + (𝑖)(𝑛)] FV= 150 000 + 150000 (0.12)
FV= 150 000 (1 + 0.12)
FV= 150 000 + 18000
FV= 150 000 (1.12)
FV= 168000
= 168 000
PV vs. FV Exercises
At the beginning of the year, BRB invested in a certificate of deposit
for one year at 12% interest per annum. BRB will receive a total
amount of P168,000 (principal investment plus interest). What could
have been the amount invested by BRB at the beginning of the year?
FV
PV = n
(1 + i )

PV PV = 168000/1.12
FV
PV = 150000
 Types of Interest
1. Simple Interest Interest paid (earned) on only the
original amount, or principal, borrowed (lent).

2. Compound Interest
Interest paid (earned) on any previous interest earned, as
well as on the principal borrowed (lent).

Compound Amount - Is the final sum-principal plus

accumulated interest at the end of the period of the
borrowing.
 Types of Interest
1. Simple Interest Interest paid (earned) on only the
original amount, or principal, borrowed (lent).

2. Compound Interest
Interest paid (earned) on any previous interest earned, as
well as on the principal borrowed (lent).

Compound Amount - Is the final sum-principal plus

accumulated interest at the end of the period of the
borrowing.
 Simple Interest
Assume that you deposit P5,000 in an account earning
6% simple interest for 2 years. What is the accumulated
interest at the end of the 2nd year?

𝑆𝐼 = 𝑃𝑜(𝑖)(𝑛)
𝑆𝐼 = 5000 (0.06)(2)
𝑆𝐼 = 300 (2)
𝑆𝐼 = 600
What is the Future Value (FV) of the deposit?
𝐹𝑉𝑛 = 𝑃𝑜 + 𝑆𝐼 = 𝑃𝑜 + 𝑃𝑜(𝑖)(𝑛)
𝐹𝑉𝑛 = 5000 + 600
𝐹𝑉𝑛 = 5 600
Compound Amount Formula

A = Compound Amount or Future Value

𝑃 = Principal or Present Value

𝒊 = interest rate per period

𝒏 = total compounding periods

 Compound Amount Formula

A = Compound Amount or Future Value

𝑃 = Principal or Present Value

𝒊 = interest rate per period

𝒏 = total compounding periods

𝒏
𝑨 = 𝑷(𝟏 + 𝒊)
�
 Compound Amount Exercises (FV)
Woo to the Young to the Woo, wants to know
how large her deposit of P50,000 today will
become at a compound annual interest rate of
10% for 5 years.
50000 10% 5000
𝒏
55000 10% 5500
C𝑨 = 𝑷(𝟏 + 𝒊)
5
C𝑨 = 50000(𝟏 + 0.10)
60500 10% 6050

𝑨 = 50000(𝟏.10) 5
66550 10% 6655

73205 10% 7320.5

𝑨 = 50000(𝟏.61051)
CI 30525.5
C𝑨 = 80525.50
CA 80525.5
 Annuities (PV and FV)

An Annuity represents a series of equal payments

(or receipts) occurring over a specified number of
equidistant periods

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.
Classifications of Annuities

Ordinary Annuity: Payments or

receipts occur at the end of each period.

Annuity Due: Payments or receipts

occur at the beginning of each period.
FV of Ordinary Annuity Formula

𝑭𝑽𝑶𝑨= Future Value of Ordinary Annuity

𝑷𝒎𝒕 = Annuity Payment
𝒊 = interest rate period
𝒏 = number of compounding periods
𝒏
(𝟏 + 𝒊) −𝟏
𝑭𝑽𝑶𝑨 = 𝑷𝒎𝒕 ×
𝒊
 FV of Ordinary Annuity Formula - Example
𝒏
(𝟏 + 𝒊) −𝟏
On January 1, 2022, BRB 𝑭𝑽𝑶𝑨 = 𝑷𝒎𝒕 ×
arranged to invest in an 𝒊
account 3
that will earn 12% interest (𝟏 + 0.12) −𝟏
compounded annually. The 𝑭𝑽𝑶𝑨 = 100000 ×
investment is for 3 years 0.12
ending
December 31. 2022. BRB plans (𝟏.4049) −𝟏
to deposit P100,00 each year 𝑭𝑽𝑶𝑨 = 100000 ×
for 3 years or a total of 0.12
P300,000, beginning
December 𝑭𝑽𝑶𝑨 = 100000 ×
31 thereof. How much balance
will the investment have on 0.12
December 31, 2025?
𝑭𝑽𝑶𝑨 = 100000 × 3.3742
𝑭𝑽𝑶𝑨 = 337420
FV of Annuity Due Formula

𝑭𝑽𝑨𝑫= Future Value of Annuity Due

𝑷𝒎𝒕 = Annuity Payment
𝒊 = interest rate period
𝒏 = number of compounding periods
𝒏
(𝟏 + 𝒊) −𝟏
FVAD = 𝑷𝒎𝒕 × × (𝟏 + 𝐢)
𝒊
 FV of Annuity Due Formula- Example
On January 1, 2022, BRB
arranged to invest P300,000
in a 4-year certificate of
deposit requiring 4 annual
deposits of P75,000 for the
next four years beginning
January 1, 2022, and every
January 1 thereafter. The
investment earns 8%
interest compounded
annually and will mature on
December 31, 2026. What
will be the value of the said
investment at the end of its
4-year maturity?
PV of Ordinary Annuity Formula
𝑷𝑽𝑶𝑨 = Present Value of Ordinary Annuity
𝑷𝒎𝒕 = Annuity Payment
𝒊 = interest rate period
𝒏 = number of compounding periods

𝒏
𝟏- [1/(𝟏 + 𝒊) ]
PVOA = 𝑷𝒎𝒕 ×
𝒊
 PV of Ordinary
Annuity - Example
• BRB arranged to invest a 4-
year investment that will
provide P75,000 cash annually
that he will collect every
December 31 of each year
beginning December 31, 2022.
The investment earns 11%
interest compounded annually
and will mature on December
31, 2025. How much should be
invested on January 1, 2022, in
order to receive P75,000
annually?
PV of Annuity Due Formula
𝑷𝑽𝑨𝑫 = Present Value of Annuity Due
𝑷𝒎𝒕 = Annuity Payment
𝒊 = interest rate period
𝒏 = number of compounding periods
PV of Annuity Due -
Example
n-1
PVAD= 32, 500 x 1- [1/ (1 + 0.08) ] + 1
On January 1, 2022, BRB
arranged to invest in a 4-year 0.08
certificate of deposit which will
provide each payout of PVAD= 32, 500 x 1- (1/ 1.2597) + 1
P32,500 annually for the next
four years beginning January 1, 0.08
2022, and every January
thereafter. The investment PVAD= 32, 500 x 1- ( 0.7938) + 1
earns 8% interest compounded 0.08
annually and will mature on PVAD= 32, 500 x 1.2062
December 31, 2025. What
0.08
amount is needed to be
invested on January 1, 2022, to PVAD= 32, 500 x 15.0775
provide a sufficient amount of
payout desired? PVAD= 490, 018. 75
Finding the Size of Each Periodic Payment
AMORTIZATION SCHEDULE

An amortization schedule is a table that

provides the details of the periodic
payments for an amortizing loan. The
principal of an amortizing loan is paid
down over the life of the loan. Typically,
an equal amount of payment is made
every period.
AMORTIZATION SCHEDULE
AMORTIZATION SCHEDULE Example

Daenerys payment int principal ending balance

Targaryen, is
end of year
borrowing
0 10000.00
P10,000 at a
compound annual 1 2774 1200.00 1574.00 8426.00
interest rate of 2 2774 1011.12 1762.88 6663.12
12%. Amortize the
3 2774 799.57 1974.43 4688.69
loan if annual
payments are 4 2774 562.64 2211.36 2477.34

made for 5 years. 5 2774.62 297.28 2476.72 0.00

Add discrepancy to
last payment Discrepancy of 0.62
Daenerys
Targaryen, is
borrowing
P10,000 at a
compound
annual interest
rate of 12%.
Amortize the
loan if annual
payments are
made for 5
years.
AMORTIZATION SCHEDULE Example

Consider a P30,000
fully amortizing loan
with a term of five
years and a fixed
interest rate of 6%.
Payments are made
on a monthly basis.
The following table
shows the
amortization schedule
for the first and last six
months.