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Time Value of Money:

Useful Shortcuts
Michael R. Roberts
William H. Lawrence Professor of Finance
The Wharton School, University of Pennsylvania

Copyright Michael R. Roberts

Last Time
Time Value of Money
Compounding

Copyright Michael R. Roberts

This Time
Time Value of Money
Useful Shortcuts

Copyright Michael R. Roberts

ANNUITY

Copyright Michael R. Roberts

Annuity
An annuity is a finite stream of cash flows
of identical magnitude and equal spacing
in time
0

Copyright Michael R. Roberts

T-1

CF

CF

CF

Annuity
An annuity is a finite stream of cash flows
of identical magnitude and equal spacing
in time
0

T-1

CF

CF

CF

E.g., Savings, vehicle, home mortgage,


auto lease, bond payments

Copyright Michael R. Roberts

Annuity
An annuity is a finite stream of cash flows
of identical magnitude and equal spacing
in time
0

Copyright Michael R. Roberts

T-1

CF

CF

CF

Annuity
An annuity is a finite stream of cash flows
of identical magnitude and equal spacing
in time
0

T-1

CF

CF

CF

*The first cash flow arrives one period from today


Copyright Michael R. Roberts

Example 1 Savings
How much do you have to save today
to withdraw $100 at the end of each
of the next 20 years if you can earn
5% per annum?

Copyright Michael R. Roberts

Example 1 Savings
How much do you have to save today
to withdraw $100 at the end of each
of the next 20 years if you can earn
5% per annum?
0

19

20

100

100

100

Copyright Michael R. Roberts

Example 1 Savings
How much do you have to save today
to withdraw $100 at the end of each
of the next 20 years if you can earn
5% per annum?
0

19

20

100

100

100

Copyright Michael R. Roberts

GROWING ANNUITY

Copyright Michael R. Roberts

Growing Annuity
A growing annuity is a finite stream of
cash flows that grow at a constant rate
and that are evenly spaced through time
0

CF

CF(1+g)

Copyright Michael R. Roberts

T-1
CF(1+g)T-2

T
CF(1+g)T1

Growing Annuity
A growing annuity is a finite stream of
cash flows that grow at a constant rate
and that are evenly spaced through time
0

CF

CF(1+g)

T-1
CF(1+g)T-2

T
CF(1+g)T1

E.g., Income streams, savings strategies,


project revenue/expense streams

Copyright Michael R. Roberts

Growing Annuity
A growing annuity is a finite stream of
cash flows that grow at a constant rate
and that are evenly spaced through time
0

CF

CF(1+g)

Copyright Michael R. Roberts

T-1
CF(1+g)T-2

T
CF(1+g)T1

Growing Annuity
A growing annuity is a finite stream of
cash flows that grow at a constant rate
and that are evenly spaced through time
0

CF

CF(1+g)

T-1
CF(1+g)T-2

T
CF(1+g)T1

*The first cash flow arrives one period from today


Copyright Michael R. Roberts

Example 2 Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on for the
next 19 years if you can earn 5% per annum?

Copyright Michael R. Roberts

Example 2 Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on for the
next 19 years if you can earn 5% per annum?
0

100

2
102.5
100 x (1 + 0.025)

Copyright Michael R. Roberts

19

20

155.966

159.865

100 x (1 + 0.025)18 100 x (1 + 0.025)19

Example 2 Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on for the
next 19 years if you can earn 5% per annum?
0

100

Copyright Michael R. Roberts

2
102.5

19

20

155.966

159.865

PERPETUITY

Copyright Michael R. Roberts

Perpetuity
An perpetuity is an infinite stream of cash
flows of identical magnitude and equal
spacing in time
0

Copyright Michael R. Roberts

T-1

CF

CF

CF

Perpetuity
An perpetuity is an infinite stream of cash
flows of identical magnitude and equal
spacing in time
0

T-1

CF

CF

E.g., Perpetuities, consol bonds

Copyright Michael R. Roberts

CF

Perpetuity
An perpetuity is an infinite stream of cash
flows of identical magnitude and equal
spacing in time
0

Copyright Michael R. Roberts

T-1

CF

CF

CF

Example 3 Savings
How much do you have to save today
to withdraw $100 at the end of each
year forever if you can earn 5% per
annum?

Copyright Michael R. Roberts

Example 3 Savings
How much do you have to save today
to withdraw $100 at the end of each
year forever if you can earn 5% per
annum?
0

100

100

100

100

Discount CFs one at a timeimpossible!


Copyright Michael R. Roberts

Example 3 Savings
How much do you have to save today
to withdraw $100 at the end of each
year forever if you can earn 5% per
annum?
0

100

100

100

100

Copyright Michael R. Roberts

GROWING PERPETUITY

Copyright Michael R. Roberts

Growing Perpetuity
A growing perpetuity is an infinite stream
of cash flows that grow at a constant rate
and that are evenly spaced through time
0

CF

CF(1+g)

Copyright Michael R. Roberts

T-1
CF(1+g)T-2

T
CF(1+g)T1

Growing Perpetuity
A growing perpetuity is an infinite stream
of cash flows that grow at a constant rate
and that are evenly spaced through time
0

CF

CF(1+g)

E.g., Dividend streams

Copyright Michael R. Roberts

T-1
CF(1+g)T-2

T
CF(1+g)T1

Growing Perpetuity
A growing perpetuity is an infinite stream
of cash flows that grow at a constant rate
and that are evenly spaced through time
0

CF

CF(1+g)

Copyright Michael R. Roberts

T-1
CF(1+g)T-2

T
CF(1+g)T1

Growing Perpetuity
A growing perpetuity is an infinite stream
of cash flows that grow at a constant rate
and that are evenly spaced through time
0

CF

CF(1+g)

T-1
CF(1+g)T-2

T
CF(1+g)T1

*The first cash flow arrives one period from today


Copyright Michael R. Roberts

Example 4 Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on forever if
you can earn 5% per annum?

Copyright Michael R. Roberts

Example 4 Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on forever if
you can earn 5% per annum?
0

100

2
102.5
100 x (1 + 0.025)

Copyright Michael R. Roberts

19

20

155.966

159.865

100 x (1 + 0.025)18 100 x (1 + 0.025)19

Example 4 Savings
How much do you have to save today to
withdraw $100 at the end of this year, 102.5 next
year, 105.06 the year after, and so on forever if
you can earn 5% per annum?
0

100

2
102.5
100 x (1 + 0.025)

Copyright Michael R. Roberts

19

20

155.966

159.865

100 x (1 + 0.025)18 100 x (1 + 0.025)19

Summary

Copyright Michael R. Roberts

Lessons
An annuity is a finite stream of cash flows
of identical magnitude and equal spacing
in time

A perpetuity is an infinite stream of cash


flows of identical magnitude and equal
spacing in time

Copyright Michael R. Roberts

Lessons
A growing annuity is a finite stream of cash
flows growing at a constant rate and equally
spaced in time

A growing perpetuity is an infinite stream of


cash flows growing at a constant rate and
equally spaced in time

Copyright Michael R. Roberts

Caution
Annuity and perpetuity formulas
assume first cash flow occurs one
period from today
Growth rate, g, must be less than the
discount rate, R, for PV formulas to
make sense
Understand excel functions
assumptions
Copyright Michael R. Roberts

Coming up next
Problem Set
Taxes

Copyright Michael R. Roberts