Chapter Two-Time Value of Money Given: FV=P10,000; r=8%; t=6yrs

PV = P10,000/(1 +0.08)6
Time Value of Money and Interest Rates
PV = P10,000(.630170)
 The time value of money is based on the
notion that a dollar received today is PV = P6,301.70
worth more than a dollar received at
Future Value of a Lump Sum
some future date
 Simple interest: interest earned on an  The future value of a lump sum equation
investment is not reinvested translates a cash flow received at the
 Compound interest: interest earned on beginning of an investment period to a
an investment is reinvested, most terminal (future) value at the end of an
common investment horizon (e.g., 5 years, 6 years, 10
years, etc.)
Present Value of a Lump Sum
The future value (FV) of a lump sum received
 The present value function converts
at the beginning of the investment horizon
cash flows received over a future
investment horizon into an equivalent FVt = PV (1 + r)t
(present) value as if they were received
Example
at the beginning of the current
investment horizon. You plan to invest today P10,000 in exchange
for a fixed payment at the end of six years. If
Discount future payments using current
the appropriate annual interest rate on the
interest rates to find the present value (PV)
investment is 8 percent compounded
PV = FVt annually, the future value of this investment is
computed as follows:
(1 + r)t
FV = PV(1+r)t
 PV = present value of cash flow
 FVt = future value of cash flow (lump Given: FV=P10,000; r=8%; t=6yrs
sum) received in t periods
FV = P10,000(1+0.08)6
 r = interest rate earned per period on
investment FV = P10,000(1.586874)
 t = number of compounding periods in
FV = P15,868.74
investment horizon
Present Value of an Annuity
Example
The present value of an annuity equation
You have been offered a security investment
converts finite series of constant (or equal)
such as a bond that will pay you P10,000 at the
cash flow received on the last day of equal
end of six years in exchange for a fixed
intervals throughout the investment horizon
payment today. If the appropriate annual
into an equivalent (present) value as if they
interest rate on the investment is 8 percent
were received at the beginning of the
compounded annually, the present value of
investment horizon.
this investment computed as follows:
PV = FVt/(1+r)t

Esguerra, K.
The present value of a finite series of equal
cash flows received on the last day of equal
Example
intervals throughout the investment horizon
You plan to invest P10,000 on the last day of
every year for the next six years. If the interest
rate on the investment is 8 percent, the future
value of this investment in six years is
computed as follows:
FV = PMT X [(1+r)t-1/r]
PV = PMT X [1-(1+R)-n]/R
Given: PMT=P10,000; r=8%; t=6yrs
PMT = periodic annuity payment
FV = P10,000[(1+0.08)6-1/0.08]
Example
FV = P10,000(7.335929)
You have been offered a bond that will pay
FV = P73,359.29
you P10,000 on the last day of every year for
the next six years in exchange for a fixed Financial Calculators
payment today. If the appropriate annual
 Setting up a financial calculator
interest rate on the investment is 8 percent, the
 Number of digits shown after decimal
present value of this investment is computed as
point
follows:
 Number of compounding periods per
PV = PMT X [1-(1+r)-n]/r year
 Key inputs/outputs (solve for one of five)
Given: PMT=P10,000; r=8%; t=6yrs
N = number of compounding periods
PV = P10,000[1-(1+0.08)-6]/0.08
I/Y = annual interest rate
PV = P10,000(4.622880)
PV = present value (i.e., current price)
PV = P46,228.80
PMT = a constant payment every period
Future Value of an Annuity
FV = future value (i.e., future price)
The future value of an annuity equation
converts a series of equal cash flows received
at equal intervals throughout the investment
Present Value of Ordinary Annuity End of the
horizon into an equivalent future amount at
Period
the end of the investment horizon. The
equation used to calculate this value is
represented as follows:

The future value of a series of equal cash flows

received at equal intervals throughout the
investment horizon

Esguerra, K.
Present Value of Annuity Due Beginning of the
Period

Future Value of Ordinary Annuity

Future Value of Annuity Due

Esguerra, K.