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Time Value of Money

The document discusses the time value of money, emphasizing that receiving money now is more valuable than receiving it later due to the potential to earn interest. It covers concepts such as future value, present value, and annuities, including formulas and examples for calculating these values. Additionally, it introduces the Rule of 72 for estimating how long it takes for an investment to double based on interest rates.

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iec2022017
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3 views

Time Value of Money

The document discusses the time value of money, emphasizing that receiving money now is more valuable than receiving it later due to the potential to earn interest. It covers concepts such as future value, present value, and annuities, including formulas and examples for calculating these values. Additionally, it introduces the Rule of 72 for estimating how long it takes for an investment to double based on interest rates.

Uploaded by

iec2022017
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Time Value of Money

Financial Management
Finance
• In all concepts of finance, none is more
important than the time value of money also
called as discounted cash flow (DCF) analysis.

Why time?
Time allows one the opportunity to postpone
consumption and earn interest.
• opportunity cost- the value of the next-
highest-valued alternative use of that resource
Time Value of Money
a concept which says it's more valuable to receive
₱100 now rather than a year from now. It also means
that receiving ₱100 one year from now is less
valuable than receiving that same ₱100 today. In
other words, the ₱100 received one year from now
has a present value that is smaller than ₱100.
Future Value
Compounding- the arithmetic process of determining the final
value of a cash flow or series of cash flows when compounding
interest is applied.
Formulas:

1 FV = PV (1 + i)ⁿ 2 FV= PV x FV factor


FV= future value
PV= present value
i= rate of interest per compounding period**
n= number of compounding periods**
Future Value
Compounded Compounded semi- Compounded quarterly
annually annually
interest will be added to interest will be added to the interest will be added to the
the account at the end of account at the end of each six- account at the end of each
the year (December 31) month period (June 30 and calendar quarter (March 31,
December 31) June 30, September 30, and
December 31

n= 1 n= 2 n= 4
i= % i= % ÷ 2 i= % ÷ 4
What if its compounded accordingly but for more than one year?
n= 1 x years n= 2 x years n= 4 x years
Future Value
Example: Find the future value of a single amount of ₱10,000
earning 8% per year compounded quarterly for two years.
1 2
FV= ?
FV= PV (1 + i)ⁿ
PV= 10,000 FV= 10,000(𝟏 + 𝟎. 𝟎𝟐)𝟖
FV= PV x (FV factor)
FV= 10,000 x (FV factor
FV= 10,000(𝟏. 𝟎𝟐)𝟖
i= 0.08 ÷ 4 = 0.02 FV= 10,000 (1.172)
for n=8, i=2%)
FV= 10,000 x 1.172
n= 4x2=8 FV= 11,7208
FV= 8 11,720
FV Factor from Table
FV Factor from Table

Standard calculator:

1.02 x 1.02 ======= 1.172


interest (i) interest (i) number of rounded up
periods (n) 3 decimal places
minus 1
The Rule of72
The rule states that an investment
or a cost will double when:
[Investment Rate per year as a percent] x
[Number of Years] = 72.
When interest is compounded annually, a
single amount will double in each of the
following situations:
Future Value
More examples:
1. Suppose you are depositing an ₱5,000 today in an account
that earns 5% interest, compounded annually. What will be the
balance in the account at the end of six years if you make no
withdrawals?
2. You are asked to determine the total future value on
December 31, 2021 of a ₱1,000 deposit made on January 1, 2017
plus a ₱5,000 deposit made on January 1, 2019. Both amounts
will earn 8% per year compounded annually.
Present Value
Discounting- the process of finding the present value of a cash
flow or a series of cash flows; reverse of the compounding
Present Value
Formulas:

1 PV = FV 2 PV = FV x [1 ÷(1 + i) ⁿ]
(1 + i)ⁿ

PV= FV x [PV factor from


3 table]
Present Value
Example: Let's assume we are to receive $100 at the end of two
years. How do we calculate the present value of the amount,
assuming the interest rate is 8% per year compounded annually?

2 3
PV Factor from Table
PV Factor from Table

Standard calculator:

1 ÷ 1.08 == 0.8573
interest (i) number of rounded up
periods (n) 4 decimal places
Present Value
Solving for number of periods and interest rate:

𝐹𝑉 𝐹𝑉
n ln i
𝑛= 𝑃𝑉 i= −1
ln 1 + 𝑖 𝑃𝑉

n&i
PV= FV x [PV factor from
table]
Present Value
More examples:
1. A company wants to accumulate ₱600,000 in 5 years. The
interest rate is 12% compounded semi-annually.
2. What is the present value of an offer of ₱15,000 one year
from now if the opportunity cost of capital (discount rate) is
12% per year nominal annual rate compounded monthly?
Present Value of Annuity
Annuity- equal payments paid to you or from you
Annuity due- when payment is made at beginning of payment period
(ex: rent paid at the beginning of each month)
Ordinary annuity/ deferred annuity/ annuities in arrears- when
payment is made at end of payment period, more common (ex: semi-
annual interest payments on bonds)

Annuity due vs Ordinary annuity

0 1 2 3 4 5 0 1 2 3 4 5

100 100 100 100 100 100 100 100 100 100 100
Present Value of Ordinary
Annuity (PVOA)
Formulas:

1 PVOA= 𝑛
σ𝑡=1
𝑃𝑀𝑇
2 PVOA = PMT x PVOA
(1+𝑖)𝑡−1
factor
PVA= present value of ordinary annuity
PMT= annuity payment
i= rate of interest per compounding period
n= number of periods
t= number of years compounding
Present Value of Ordinary
Annuity (PVOA)
Example: If an ordinary annuity consists of 10 payments of
$1,000 each and the interest rate for discounting is 8%, the
present value of the ordinary annuity is:

2
PVOA Factor from Table
PVOA Factor from Table

Standard calculator:

1 + .08 ÷÷ ========== -1 ÷ 0.8 = 6.710


interest (i) number of interest (i) rounded up
periods (n) 3 decimal
places

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