BUSINESS

FINANCE
4th Quarter

Prepared By:
MARY MILDRED P. DE JESUS
OBJECTIVE:
Define Future value and time value of
01 money

Identify what is annuity and the types of

02 Annuities

Solve problem of different annuities

03
TImE PrEsEnT ValuE and
annuITIEs
 TImE ValuE Of mOnEy
 The time value of money (TVM) is the
concept that money you have now is worth
more than the identical sum in the future
due to its potentia learning capacity.This
core principle of finance holds that provided
money can earn interest, any amount of
money is worth more the sooner it is
received. TVM is also sometimes referred to
as Present Discounted value.
 TImE ValuE Of mOnEy
 If you ask your parents (or even your
grandparents) the price of a goods in the past,
you might be suprised that things were so
cheap in the past. However, the simply
illustrates the concept of the time value of
money.
 The time value of money would tell us that a
perso today is not equal to a peso in the future.
 Many things contribute to the change in the
time value of money such as opportunity cost
as well as inflation.
 TImE ValuE Of mOnEy
This section shall be divided into
the following parts:
A. Lump-sum payment
B. Annuties
 Ordinary annuity
 Annuity due
C. Perpetuity
 lumP-sum PaymEnT
is a large amount of money paid
once and in full rather than in
smaller payments over time. They
often occur with legal settlements,
inheritances, lottery winnings,
and retirement plans.
PurPOsE Of lumP-sum PaymEnT
 The purpose of lump sum payments is to
streamline the transaction and eliminate the need
for additional payments down the road.
 Lump sum payments have several advantages,
including flexibility and simplicity. However, they
can also be disadvantageous if the recipient is not
prepared to manage a large sum of money at once.
 Lump sum payments can also be subject to higher
taxes, so it is essential to consult a tax professional
before agreeing to any lump sum payment.
sInglE lumP-sum PaymEnT
 We use the same formula provided for under
compound interest rates as shown below:
PV = FV x (1 + i)-n
Where:
FV = future value
PV = present value
I = effective interest rate
n = time periods
(1+i)n = present value factor
 sInglE lumP-sum PaymEnT
 To illustrate this concept, let’s assume that you
told the banker that you need not obtain the loan
now and will instead but the equipment from the
supplier under deferred payment terms.
 The term provided to you by the supplier is to pay
P150,000 by issuing a non-interest bearing note.
 A non-interest bearing note is a note does not
require payment of interest.
 A similar note payable under normal conditions
with the bank would yield a rate of 10% (note that
yield rate is also called effective rate).
sInglE lumP-sum PaymEnT
First, let us compute the present
value of the note with a future value
of P150,000, an effective rate of 10%
and a term of 3 years as shown
below:
 sInglE lumP-sum PaymEnT
 First, let us compute the present value of the note
with a future value of P150,000, an effective rate of
10% and a term of 3 years as shown below:

PV = FV x (1 + i)-n
PV = 150,000 x (1 + 0.10)-3
PV = 150,000 x 0.7513
PV = 112.695 (rounded)
 sInglE lumP-sum PaymEnT
 Please take note that the present value factor for 3
years at an effective rate of 10% is 0.7513
(rounded). You can verify this amount by
consulting with a present value factor table (see
appendix).
 Under a non-interest bearing note, we simply
assume that the P150,000 already includes
payment for interest. We can view the present
value of the loan as the actual principal of the loan
with a 10% compound interest rate. This can be
proven by the table
sInglE lumP-sum PaymEnT

 Please note that all values in the table above are

rounded off to the nearest peso. You would see that
the unpaid balance at the end of the third year is
approximately 150,000. The difference of P2 is due to
rounding off the present value factor as well as
interest.
 annuITIEs
 is a series of recurring cash payments
that occur at regular intervals, such as
rent on an apartment, a monthly
mortgage loan payment, or monthly auto
loan payments.
 In ordinary annuities, payments are made
at the end of each period. With annuities
due, they're scheduled at the beginning of
the period.
 annuITIEs
 The supplier offered you an alternative payment
scheme. Let us assume that the supplier allowed
you to pay the equipment under installment
basis of P50,000 annually. This payment
scheme would illustrate an annuity wherein
equal cash flows are to be made every period.
The timing of the payment would dictate
whether the scheme is that of an ordinary
annuity or an annuity due.
 OrdInary annuITy
 Under the Ordinary annuity, the cash flows
(installment payments) would always occur at
the end of each time period. Therefore, under
ordinary annuity, you are required to make
yearly payments of P50,000 to the supplier at
the end of each period for three years.
 OrdInary annuITy
 The formula for the present value of an ordinary
annuity is shown below:

 By substituting the details found in our

computation earlier, we get the present value as
follows:
 OrdInary annuITy

• Take note that the 2.4869 is also called the

present value factor of an ordinary annuity for 3
years at an effective rate of 10% which can be
verified by consulting with a present value
factor table.
 OrdInary annuITy

• It can be seen that it would be more costly for us to pay

on installment because the present value computed for
ordinary annuity of P124,345 is higher than the present
value under the lump-sum payment of P112,695. Again,
we can assume that the interest is already imputed in the
payment and that we obtained a loan of P124,345 payable
in 3 equal annual installment of P50,000 each.
 OrdInary annuITy

• All values in the table are rounded off to the nearest peso.
Again, the unpaid balance at the end of the third year of
P4 is due to rounding off. We can see that the unpaid
balance at the end of the term of the note approximates
zero. This means that once we pay P50,000 for year for
three years, we would already fully pay the P150,000
equipment.
 OrdInary annuITy
• To compute for the future value of the loan, let us first
take a look at the formula:
 OrdInary annuITy
• Take note that the 3.3100 is also called the future
value of an ordinary annuity for 3 years at an effective
rate of 10% which can be verified by a future value
factor table. The future value would tell us that we
paid an equivalent of P165,500 on the end of the third
year over the three years terms of the loan.
 annuITy duE
 It is an annuity in which the cash flows, or
payments, occur at the beginning of the period.
An annuity due is also called an annuity in
arrears.
 The formula for the annual payments and
present value are shown below:
 annuITy duE
 Take note that the formulas provided above are similar
to the formula for ordinary annuity except for the
addition of a multiplier for the factor (1+i).
 In our earlier example, if the supplier would allow us
to pay P50,000 annually for three years with the first
payment due immediately, how much would be the
present value and the future value of our payments?
Let us apply the formulas and find out?
 annuITy duE

 Again, note that the present value factor of an annuity

due for three years at a rate of 10% is 2.7355. This
can be verified by consulting with a present value
factor.
 annuITy duE

 Please take note that the P2 difference us again due to

rounding off of the present value factor and the interest.
Notice that by the end of the 2nd year, you have already
fully paid the purchase price of the equipment. This is
because you are paying the P50,000 in advance under the
terms of annuity due as compared to the ordinary annuity.
 annuITy duE
 The computation of the future value of the three payments
is shown below:

 Take note that the 3.6410 is also called the future value of
an annuity due for 3 years at an effective rate of 10% which
can be verified by a future value factor. The future value
would tell us that we paid an equivalent of P182,050 at the
end of the third year over the 3 years terms of the loan.
 PErPETuITy
 It is a type of annuity that is set up so that the
payments will never end. There is no set
maturity date.
 As long as an investor owns a perpetuity, they
will keep receiving payments. When the investor
dies, the perpetuity will pass on to their heirs
and keep making payments as normal.
annuITIEs and PErPETuITIEs
 Most annuities eventually stop making
payments. They might stop making payments
after a set number of years or after the contract
owner dies.
 However, if an annuity is set up so that it never
stops making payments, then it is a perpetuity.

 In other words, all perpetuities are annuities,

but not all annuities are perpetuities.
 PErPETuITy fOrmula:

Present Value of Perpetuity Formula:

PV = C /R
Where:
PV = Present Value
C = Amount of continuous cash payment
R = Interest rate or yield
 PErPETuITy fOrmula:
 Company “Rich” pays P2 in dividends annually
and estimates that they will pay the dividends
indefinitely. How much are investors willing to
pay for the dividend with a required rate of
return of 5%?
 PErPETuITy fOrmula:
Solution:
PV = 2/5%
PV = P40
 An investor will consider investing in the
company if the stock price is P40 or less.
summary Of fOrmulas:
Thank you
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