TIME VALUE OF MONEY

JENY VARONA LUZURATA

RONA RAMOS
SARAH ABEGAIL BARCELONA
INTRODUCTION
 “A Peso Received Today Is Worth More Than a
Peso Received in The Future”.

 The time value of money impacts business

finance, consumer finance, and government
finance.

 Time value of money results from the concept of

interest. - is a cost of using money over time or
the sum of money paid for the use of money
 Interest and Time Value of Money are
considerations in decisions involving expenditures
for business investments and the acquisition of
operating assets.

 Time Value of Money involves 2 major concepts:

 Future Value
 Present Value

 3 factors considered by both of the 2 concepts:

 Principal
 Interest Rate
 Time Period
SIMPLE INTEREST
 it is the interest paid or earned on the initial
principal only.

 Interest (I) is a sum of money for the use of money.

 Principal (P)
 Rate of interest (r)

 Length of time (t)

 Formula: I=Prt
Example:
Venus deposited P5,000 in a bank at 6.5% simple interest for 2
years. How much will she earns after 2 years, assuming that no
withdrawals were made?

solution:
P = P5,000 r = 6.5% or 0.065 t = 2 years I=?

I =Prt
= (P5,000) (0.065) (2)
= P650.00 (interest)
To find also the rate, r, the time, t, and the principal,
P, and also the future amount, F, we use the following
formula:

r=I/Pt

t=I/Pr

P = I / r t or P = F / 1 + r t

F = P (1 + r t)
COMPOUND INTEREST
 It is the interest paid on both the principal and
the amount of interest accumulated in the prior
period.
 Compounding is the process called for
determining future value when compound
interest is applied.
 Formula:

F = P (1 + i ) n
Example:
Venus deposited P5,000 in a bank at 6.5%
compounded annually for 2 years. How much will she
earns after 2 years, assuming that no withdrawals
were made?

solution:
F = P (1 + i ) n
= P5,000 ( 1 + 0.065) 2
= P5,671.125
 SIMPLE INTEREST COMPARED WITH COMPOUND
INTEREST
 Example:
 ABC Corporation leaves its P10,000 on deposits for
five years in a bank paying 10% annual interest.
Simple Interest Compound Interest
Year Beginning Simple Ending Beginning Compound Ending
amount interest amount amount interest amount
1 P10,000 P1,000 P11,000 P10,000 P1,000 P11,000
2 P10,000 P1,000 P12,000 P11,000 P1,100 P12,100
3 P10,000 P1,000 P13,000 P12,100 P1,210 P13,310
4 P10,000 P1,000 P14,000 P13,310 P1,331 P14,641
5 P10,000 P1,000 P15,000 P14,641 P1,464.10 P16,105.10
Total P5,000 P6,106.10
interest
FUTURE VALUE (ANNUAL COMPOUNDING)

 Formula:

 FVn = PV ( 1 + i)n

 FVn -- future value

 PV -- initial principal amount
i -- interest rate (compounded)
n -- periods
Example:
The future values of P10,000 compounded at a 10%
annual interest rate at the end of one year, two years
and five years are computed as follows:

Year Calculation Future Vale

1 FV1 = (P10,000)(1+0.10)1 P11,000
2 FV2 = (P10,000)(1+0.10)2 P12,100
= (P10,000)(1,21)
5 FV5 = (P10,000)(1+0.10)5 P16,105.10
=(P10,000)(1.61051)
FUTURE VALUE ( WITH INTRAPERIOD COMPOUNDING)

 It is compounding that occurs more than once

a year.
 Formula:
 FVn = PV (1 + i/m)mn

 FVn -- future value

 PV -- initial principal amount
i -- interest rate (compounded)
n -- periods
m --number of compounding period per year
Example:
Instead of placing P1,000 in Atlanta Bank that pays 10%
interest annually, the financial manager decides to put the
money in National Bank that pays 10% interest compounded
semi-annually. Between the two banks, there would be a
difference in the future value of your investment after one year.

Atlanta Bank National Bank

Annual Compounding Semi-annual Compounding

FV1 = (P1,000)(1 + 0.10)1 FV1 = (P1,000)(1 +0.10/2)(2)(1)

= (P1,000)(1.10) = (P1,000)(1.1025)
=P1,100 = P 1,102.50
 NOMINAL INTEREST RATE COMPARED TO
EFFECTIVE INTEREST RATE
 Nominal Interest Rate is simply the stated rate while
the Effective Interest Rate or also called Annual
Percentage Rate (APR) is the true interest rate and
may differ from nominal rate depending on the
frequency on compounding.

 Formula;

 APR = (1 + i/m )m - 1
Example:
Disney Incorporated deposits money in a bank
that pays 10% nominal interest and
compounds interest semi-annually.

APR = (1 + 0.10/2)2 – 1
= (1.05)2 -1
= 1.1025 – 1
= 0.1025 or 10.25%
Comparison or results of different compounding periods for
P1,000 invested at a 10% interest rate for one year

Initial Investment Compounding Future Value Annual

Period Percentage Rate

P1,000 Annually P1,100 10%

P1,000 Semi-annually P1,102.50 10.25%

P1,000 Quarterly P1,103.81 10.38%

P1,000 Monthly P1,104.71 10.47%

 DETERMINATION OF THE FUTURE VALUE OF A
STREAM OF PAYMENTS
 Future Value Determination Involving a Stream
of Unequal Payments

 In calculating the future value of an unequal stream

of payments, find the future value of each payment
at a specified future date and then sum it up.
Example:
A firm plans to deposit P2,000 today and P1,500 one
year from now at Mount Carmel Rural Bank. No future
deposits or withdrawals are made and the bank pays
10% interest compounded annually. The future value
of the account at the end of four years is computed to
be:
FV4 = (P2,000)(1.10)4 + (P1,500)(1.10)3
= (P2,000)(1.464) + (P1,500)(1.331)
= P2,928 + P1,996.50
= P4,924.50
 Future Value Determination Involving a Stream
of Equal Payments

A stream of equal payments made at regular time

intervals is an annuity

 There are two types of fixed annuities:

 Ordinary Annuity
 Annuity Due
1. ORDINARY ANNUITY
 It is one in which payments or receipts occurs
at the end of each period.

 Formula:
 FVOA n = A ((( 1 + i ) n – 1) / i )

FVOA n - future value of ordinary annuity

A - amount of fixed annuity payment
LET'S NOW RUN THROUGH EXAMPLE 1. CONSIDER THE
FOLLOWING ANNUITY CASH FLOW SCHEDULE:
TO CALCULATE THE FUTURE VALUE OF THE ANNUITY, WE HAVE
TO CALCULATE THE FUTURE VALUE OF EACH CASH FLOW. LET'S
ASSUME THAT YOU ARE RECEIVING $1,000 EVERY YEAR FOR
THE NEXT FIVE YEARS, AND YOU INVESTED EACH PAYMENT AT
5%. THE FOLLOWING DIAGRAM SHOWS HOW MUCH YOU WOULD
HAVE AT THE END OF THE FIVE-YEAR PERIOD:
 this is formula that serves as a shortcut for
finding the accumulated value of all cash flows
received from an ordinary annuity:

FVOA n = A ((( 1 + i ) n – 1) / i )
= $1,000 ((( 1 + .05) 5 -1 ) / .05)
= $5,525.63
Example:
Crystal Corporation deposits P1,000 at the end of
each of three years in a bank account paying 10%
interest compounded annually. The value of the
account at the end of the third year is computed by:

FVOA3 = (P1,000) (((1+0.10)3 -1)/0.10)

= (P1,000)(3.310)
= P3,310
2. ANNUITY DUE

 It is one which payments or receipts occur at

the beginning of each period.
 Formula:
 FVAD n = A ((1 + i )n – 1) / i)(1 + i)

FVAD n - future value of an annuity due

A - amount of fixed annuity payment
WHEN YOU ARE RECEIVING OR PAYING CASH FLOWS
FOR AN ANNUITY DUE, YOUR CASH FLOW SCHEDULE
WOULD APPEAR AS FOLLOWS:
EXAMPLE:
$1,000 PAYMENT IS MADE AT THE BEGINNING OF THE
PERIOD RATHER THAN AT THE END (INTEREST RATE IS
STILL 5%):
 The future value of this annuity can use this
formula:

FVAD n = A ((1 + i )n – 1) / i)(1 + i)

= $1000 (( 1 + .05) 5 – 1) / i) ( 1+.05)
=$ 5801.91
Example
Instead of depositing P1,000 at the end of the year for
three consecutive years, the firms makes deposits at
the beginning of each year. Interest is compounded
annually at 10%. How much will the firm have in
account after three years?

FVAD3 = (P1,000)(3.310) (1.10)

= (P1,000)(3.641)
= P3,641
PRESENT VALUE

 It is the current value of a future amount of

money, or series of payments, evaluated at an
appropriate discount year.

 Discount rate is the rate of the interest that is

used to find present values.
DISCOUNTING
 It is the process of determining the present
value of the future amount.

Formula:

PV = FVn / (1 + i)n

PV = FVn (1 + i)-n
Example

Blueberry Company expects to receive P1,100 one year from

now. What is the present value of this amount if the discount
rate is 10%?

PV = FVn / (1 + i)n

PV = P1,100 / (1 + 0.10)1
= P1,100 / 1.10
= P1,000
DETERMINATION OF THE PRESENT VALUE OF A
STREAM OF PAYMENTS

 Present Value Determination Involving a

Stream of Unequal Payments
 To find the present value of an unequal or mixed
stream of payments, simply calculate the present
value of each future amount separately and then
add these present values together.
Example:
MNM Company expects to receive payments of
P1,000, P1,500 and P2,000 at the end of one, two
and three years, respectively. The present value of this
stream of payments discounted at 10% is computed
as follows:

PV = (P1,000)(0.909) + (P1,500)(0.826) +
(P2,000)(0.751)
= P909 + P1,239 + P1,502
= P3,650
 Present Value Determination Involving a
Stream of Equal Payments
 The present value of an equal payments is found by
using the equation below.

PVOA n = A { ∑ 1 / (1 + i) t }

 This equation, the annuity payment, A, is multiplied

by the term in bracket, which is the sum of the
individual present value interest factors.
Example:
Summer Corporation expects to receive P1,000
at year’s end for the next 3 years. The present
value of this annuity discounted at 10% is
computed as follows:

PVOA n = (P1,000) { ∑ 1 / (1 + i) t }
= (P1,000) (0.909 + 0.826 + 0.751)
= (P1,000) (2.486)
= P2,486.00
DETERMINATION OF THE PRESENT VALUE OF A
PERPETUITY
 Perpetuity – is an annuity with an infinite life:
that is, the payments continue indefinitely.

 The present value of perpetuity is found by

using the equation below:

PV of a perpetuity = annuity / discount rate

Example:
Honey Dew Corporation wants to deposit an amount of
money in the bank account that will allow it to
withdraw P1,000 indefinitely at the end of the year
without reducing the amount of initial deposit. If a
bank guarantees to pay the firm 10% interest on its
deposits, the amount of money the firm has to
deposits is computed as follows:

PV of a perpetuity = P1,000 / 0.10 = P10,000

BOTTOM LINE

 Time literally is Money - the value of the money

you have now is not the same as it will be in the
future and vice versa.

 So, it is important to know how to calculate the

time value of money so that you can distinguish
between the worth of investments that offer
you returns at different times.