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Time Value of Money: Abm5 - Business Finance

Here are the steps to solve this problem: 1) Calculate the future value of options 2 and 3 using the FV formula 2) Compare the FVs to the upfront amount in option 1 3) Recommend the best option Please let me know if you need help with the calculations.

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Barbie Bleu
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342 views34 pages

Time Value of Money: Abm5 - Business Finance

Here are the steps to solve this problem: 1) Calculate the future value of options 2 and 3 using the FV formula 2) Compare the FVs to the upfront amount in option 1 3) Recommend the best option Please let me know if you need help with the calculations.

Uploaded by

Barbie Bleu
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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TIME VALUE OF MONEY

ABM5 – BUSINESS FINANCE


TIME VALUE OF MONEY

 the idea that money available at the present time is


worth more than the same amount in the future due
to its potential earning capacity. (Investopedia)
Interest

 the cost of holding money. It is the amount charged


by the lenders to the borrowers/ users of money, and
is usually paid at regular intervals.
Simple Interest

 the charging interest rate r based on a principal P over


T number of years.
 Interest = P x r x T
 Principal = PHP500,000
Rate = 8%
Time = 5 years
 Thus, Interest = 500,000 x .08 x 5 = PHP200,000
Compound Interest

 ^T
  x m) ) - P
 Principal = PHP500,000
Rate = 8%
Time = 5 years
Compounding frequency = annually
 Thus, Interest = 500,000 x (1 + (0.08/1))(5x1) –
500,000 = PHP234,664.04
Compounding Frequency

- the number of times interest is computed on a certain


principal in one year.
- Annual - 1
- Semi-annual - 2
- Quarterly - 4
- Monthly - 12
Effective Annual Interest Rate

 rate of interest actually earned on an investment or


paid on a loan as a result of compounding the interest
over a given period of time.
Nominal Interest Rate

 A nominal interest rate is the stated rate indicated by


a financial instrument that is issued by a lender or
guarantor.
Future Value

 amount to which an investment will grow after


earning interest.
Formula: Future Value
Example of FV

 What
  amount will they receive (what is the future
value) if PHP150,000 is invested at 6% per annum
compounded semi-annually for 3 years?
 Step 1: Arrange the given using the formula

 Step 2: Use the PEMDAS process to know which step


is first to use.
Present Value

 Present Value - the amount you have to invest today if


you want to have a certain amount of cash flow in the
future.
Formula: Present Value
Example of PV

 You
  need P25,000.00 to buy a laptop when you enter
into college 2 years from now. How much must you
invest now if the interest rate is at 6% per annum?
 Step 1: Arrange the given using the formula

 Step 2: Use the PEMDAS process to know which step


is first to use.
PV = 25,000/(1.062) = PHP22,249.9
Basic Patterns of Cash Flow

 Single Amount (Lump Sum) - a single cash outflow is


made and the total receipts will be at a single future
date.
 Annuity - periodic stream of equal cash flow at equal
time intervals (annually, monthly, etc.). For example,
payment for a certain item shall be for 12 equal
monthly installments of PHP1,000.
Basic Patterns of Cash Flow

 Mixed Stream - unequal periodic cash flows that


reflect no particular pattern.
FV and PV in Mixed Streams of Cash
Flows

 Future Value: Suppose that you choose to put your


savings annually in MRI bank at 8% per annum. For
today, you put PHP1,200, on the second year
PHP1,400, and PHP1,000 for the third year. How much
will you have available at the end of three years?
FV and PV in Mixed Streams of Cash
Flows
FV and PV in Mixed Streams of Cash
Flows
FV and PV in Mixed Streams of Cash
Flows

 Present Value: Suppose that you can buy a phone for


PHP8,000 down payment with 4,000 for each of the
next two years or pay PHP15,500 cash today. Given an
interest rate of 8%, which is a cheaper alternative?
FV and PV in Mixed Streams of Cash
Flows
Annuity

 It is a stream of equal periodic cash flows over a


specified period.
 2 types: Ordinary Annuity and Annuity Due.
 Ordinary annuity payments are made at the end of
each period (usually annually)
 Annuity due, the cash flow occurs at the beginning of
each period.
Ordinary Annuity

  Future Value Formula:

 Present Value Formula:


Future Value of Ordinary Annuity

 Illustration: Mr. Mendoza wishes to determine how


much the value of his savings in 5 years will be if he
will put PHP1,000 per year in a bank which provides 7%
interest per annum.
 Answer: PHP 5,750.70
Present Value of Ordinary Annuity

 Illustration: Mr. Yusoph wants to buy a pair of shoes worth


PHP10,500. He has the option of paying it today for PHP10,500
or buying them in installment where he has to pay a down
payment of PHP4,000 today, and the balance will be paid in
two equal payments of PHP4,000 each for the next two years.
Given an interest rate of 10%, which is the better option?
 PV = 4,000 + 4000 x (PVA factor) = PHP10,932.00 for buying on
installment vs. PV PHP10,500 for buying today.
 Since buying on installment would be more expensive, Mr.
Yusoph should buy the pair of shoes today.
Group Exercises

(EASY)
 1. You deposited PHP1,500 in a bank with an interest
rate of 5% for 1 year. What is the future value of your
deposit?
Answer Key:

 EASY
1. FV = PHP 1,575
Group Exercises

(AVERAGE TO DIFFICULT)
 1. FNB pays 6% interest compounded semi-annually.
SNB pays 6% compounded monthly. Which bank
offers the higher effective annual rate?
Answer Key:

 AVERAGE to DIFFICULT
1. FNB = 6.09%
SNB = 6.17%
Therefore, SNB is better.
Group Exercises

 2. Compute the present value and future value of


PHP100 cash flow for the following combination of
discount rates and times:
a. r = 8%, t = 5 years
b. r = 8%, t = 10years
c. r = 5%, t = 5years
d. r = 5%, t = 10 years
Answer Key

 2.
Group Exercises

 3. You deposit PHP1,000 in your bank account. If the


bank pays 4% simple interest, how much interest will
you accumulate in your account after 10 years? What
if the bank pays compound interest?
Answer Key

 3. Simple Interest = 1000 x .04 x 10 = 400


Compound Interest = 1000 x (1.0410) – 1000 = 480.24
Assignment (1/2 CW)

 Mr. Sotto won PHP10 million in the lottery. He was very excited
to collect his winnings and had several plans for his PHP10
million. He would buy his dream house, car, and a lot more.
However, he was very disappointed when the officers from
PCSO said that he will not get his PHP10 million pesos upfront.
He, however, has the following options: Get 8.1 million upfront,
Receive 1 million every year for 10 years, or Receive 1.8 million
every year for 5 years
The current government bonds have a yield of 5% per annum.
Which is the best option?

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