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Time Value of Money Time Value of Money

The document discusses the time value of money and compound interest. It explains that money today is worth more than the same amount in the future due to interest earnings. Compound interest earns interest on prior interest amounts as well as the principal, resulting in higher returns than simple interest which only applies to the principal. The document provides formulas to calculate future and present value under simple and compound interest models using interest rates and time periods. Tables can also be used to look up future value index numbers.

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Mishra Soumya
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Download as PPT, PDF, TXT or read online on Scribd
27 views

Time Value of Money Time Value of Money

The document discusses the time value of money and compound interest. It explains that money today is worth more than the same amount in the future due to interest earnings. Compound interest earns interest on prior interest amounts as well as the principal, resulting in higher returns than simple interest which only applies to the principal. The document provides formulas to calculate future and present value under simple and compound interest models using interest rates and time periods. Tables can also be used to look up future value index numbers.

Uploaded by

Mishra Soumya
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Time Value of Time Value of Money Money

The Interest Rate


Which would you prefer -- Rs10,000 today or Rs10,000 in 5 years? years

Obviously, Rs10,000 today. today You already recognize that there is TIME VALUE TO MONEY!! MONEY

Why TIME?
Why is TIME such an important element in your decision?
TIME allows you the opportunity to postpone consumption and earn INTEREST. INTEREST

Types of Interest
x

Simple Interest
Interest paid (earned) on only the original amount, or principal borrowed (lent).

Compound Interest

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

Simple Interest Formula


Formula SI: P0: SI = P0(i)(n) Simple Interest Deposit today (t=0)

i: Interest Rate per Period n: Number of Time Periods

Simple Interest Example


Assume that you deposit Rs1,000 in an

account earning 7% simple interest for 2 years. What is the accumulated interest at the end of the 2nd year?

SI

= P0(i)(n) = Rs1,000(.07)(2) = Rs140

Simple Interest (FV)


What is the Future Value (FV) of the FV

deposit?

= P0 + SI = Rs1,000 + Rs140 = Rs1,140 Future Value is the value at some future time of a present amount of money, or a series of payments, evaluated at a given interest rate.

FV

Simple Interest (PV)


What is the Present Value (PV) of the PV

previous problem?

The Present Value is simply the Rs1,000 you originally deposited. That is the value today! Present Value is the current value of a future amount of money, or a series of payments, evaluated at a given interest rate.

Future Value (U.S. rs)

Why Compound Interest?

Future Value Single Deposit (Graphic)


Assume that you deposit Rs1,000 at a compound interest rate of 7% for 2 years. years
0 7% 1 2

Rs1,000
FV2

Future Value Single Deposit (Formula)


FV1 = P0 (1+i)1 = Rs1,000 (1.07) = Rs1,070 Compound Interest You earned Rs70 interest on your Rs1,000 deposit over the first year. This is the same amount of interest you would earn under simple interest.

Future Value Future Value Single Deposit (Formula) Single Deposit (Formula)
FV1 = P0 (1+i)1 = Rs1,000 (1.07) = Rs1,070 FV2 = FV1 (1+i)1 = P0 (1+i)(1+i) = Rs1,000(1.07)(1.07) = P0 (1+i)2 = Rs1,000 Rs1,000(1.07)2 = Rs1,144.90 Rs1,000
You earned an EXTRA Rs4.90 in Year 2 with compound over simple interest.

General Future Value Formula


FV1 FV2 = P0(1+i)1 = P0(1+i)2

General Future Value Formula: FVn = P0 (1+i)n or FVn = P0 (FVIFi,n) -- See Table I

Valuation Using Table I


FVIFi,n is found on Table I at the end of the book or on the card
insert.

Period 1 2 3 4 5

6% 1.060 1.124 1.191 1.262 1.338

7% 1.070 1.145 1.225 1.311 1.403

8% 1.080 1.166 1.260 1.360 1.469

Using Future Value Tables


FV2 = Rs1,000 (FVIF7% ,2) = Rs1,000 (1.145) = Rs1,145 [Due to Rounding] 6% Period 7% 8% 1 1.060 1.070 1.080 2 1.124 1.145 1.166 3 1.191 1.225 1.260 4 1.262 1.311 1.360 5 1.338 1.403 1.469

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