Time Value of Money

Money Today Money Tomorrow

Money Today and Tomorrow

Would you rather have 1,000 today, or 1,000
next year?
1,000 today please.
I could invest todays money and earn interest (yield)
I might die before next year or I might not get paid
(risk)
By next year, prices might have gone up so I cant buy
as much (inflation)
I want to spend it now and not wait (opportunity
costs)

Money Tomorrow

BUT
Would you rather have:
1,000 today or
1,100 next year or
1,500 in 4 years or
4,000 in 7 years?
It all depends

Compound Interest
If I have 1,000 today, I can invest that and earn
interest.
If I invest 1,000 at 8% interest:
Year 1 1,000 + interest 80 = 1,080
Year 2 1,080 + interest 86.4 = 1,166.4
Year 3 1,166.4 + interest 93.31 =1,259.71
Year 4 1,259.71 + interest 100.78 = 1,306.49
Year 5 1,360.49 + interest 108.84 = 1,469.33

Future Value & Present Value

From the previous calculations, at 8% interest:

1,000 is the same as 1,080 in 1 years time
Or 1,166 in 2 years time
Or 1,259 in 3 years time etc.
The Future Value of 1,000 in 3 years time @
8% is 1,166
The Present Value of 1,166 to be received in
3 years time @ 8% is 1,000

Future Value
The Future Value is also know as The Amount
of 1.
How much 1 will amount to, if invested now
for a certain number of years, at a certain
amount.

Formulae
We just worked out the values by adding them
up, year on year.
There is a formula for working out the amount
Future Value, or Amount of 1, =
(1+i)n
Where i = interest rate
n = number of years

Amt of 1 or Future Value

Lets check:
1,000 in 1 years @ 8%
1,000 * (1+i)
= 1,000 * (1+.08) = 1,000 * (1.08) = 1,080
1,000 in 2 years @8%
= 1,000 * (1.08)2 = 1,000 * 1.1664
1,000 in 3 years
= 1,000 * (1.08)3 = 1,000 * 1.259712
= 1,259.71

Present Value
We have just seen that, @ 8% return, 1,000
today is the same as 1,259 in 3 years time.
On the same basis, if we were going to receive
a lump sum of 1,259 in 3 years time, that is
only worth 1,000 today.
This is known as the Present Value.
The formula is the reciprocal of the FV formula
1/(1+i)n

Present and Future Value

To Recap:
Money tomorrow is not worth as much as
money today
To find the value today of a future sum, we
need to find the Present Value. We can use
the formula 1/(1+i)n
To find out how much a sum of money will
amount to in a given number of years we use
the Amount of 1 or Future Value (1+i)n

Where would we use it? Examples

We have a disused storage yard, just out of
town. If we turn it into a car-park, it would be
worth 150,000. Its going to take us 2 years
to get Planning Permission. Assuming a return
of 5 %, what is its present value?
This building needs re-roofing in 7 years time
at a cost of 7,500. I have 5,000 put away
earning 6% return. Will that cover it?