This action might not be possible to undo. Are you sure you want to continue?

BF06: Time will Tell Time Value of Money

**Specific Learning Objectives
**

• Explain Time value of money (TVM) concept. • Differentiate between the concepts of discounting and compounding. • Compute present / future value of multiple cash flows and annuities. • Apply TVM concept to financial decision-making and investment decisions.

Problem Analysis

Alabama Tigers

4 Options :

• • • • Nikey Ltd Reeback Ltd Xtreme Ltd Embro Ltd

Sponsorship Rights

Sell exclusive rights to sponsor for a period of 3 years

How to evaluate these options with different methods of payment & decide which is best?

One dollar in hand today is worth more than a dollar promised some time in the future because of the returns that could be earned while waiting. you would opt for Option A.If you could choose… Option A Get $1 Today Option B Or Get $1 in a year’s time Obviously. .

is calculated only on the beginning For instance.03 x 1= $3 $100 x 0. if you invest $100 at a simple interest rate of 3% per annum.03 x 1= $3 Value of investment at end of period P + I1 = $103 P + I1 + I2 = $106 P + I1 + I2 + I3= $109 P + I1 + I2 + I3 + I4 = $112 P + I1 + I2 + I3 + I4 + I5 = $115 .03 x 1= $3 $100 x 0.03 x 1= $3 $100 x 0. the values of the investment at the end of each period are as follows (assuming no further inflow or outflow of the initial amount invested): Year Year 1 Year 2 Year 3 Year 4 Year 5 Interest earned per period P x R x T = I1 P x R x T = I2 P x R x T = I3 P x R x T = I4 P x R x T = I5 Interest earned per period $100 x 0.Recap on Simple Interest Simple interest principal.03 x 1 = $3 $100 x 0.

Year Interest earned per period Interest earned per period Value of investment at end of period P + I1 = $103 P + I1 + I2 =$106.93 Year 1 Year 2 Year 3 Year 4 Year 5 P x R x T = I1 (P + I1) x R x T = I2 (P + I1 + I2) x R x T = I3 $100 x 0.03 x 1 = $3.18 $109.09 x 0.03 x 1 = $3 $103 x 0.27 x 0.38 .55 P + I1 + I2 + I3 + I4+ I5 =$115.09 $106. our investment of $100 will look like this instead. Using the earlier example with the difference of a compound interest of 3% instead of a simple interest.03 x 1= $3.09 P + I1 + I2 + I3 =$109.27 P + I1 + I 2 + I 3 + I 4 =$112.28 (P +I1+I2+I3) x R x T = I4 (P + I1+I2+I3+I4) x R x T = I5 $112.55 x 0.Recap on Compound Interest Compound interest is calculated on the beginning principal AND the interest accumulated as well.03 x 1 = $3.03 x 1 = $3.

Compound Interest Using EXCEL function: Step 1 : Click ‘fx’ on menu bar Step 2 : Type ‘FV’ on Search for a function Step 2 : Or Click on ‘FV’ Step 3 : Click ‘OK’ .

of periods and PV Step 5 : Click ‘OK’ . No.Compound Interest Using EXCEL function: Step 4: Enter Rate.

50 in a year’s time How will you decide? Will the $0.50 be enough to compensate you for the 1 year wait? .If you could choose again… Option A Get $1 Today Option B Or Get $1.

03) = $1.50 is much more than $1.03 r = interest rate/rate of return/discount rate Since $1. after 1 year we will be getting: $1 x (1+r) = $1 x (1.03. Assuming we could invest the money at 3%. we should choose option B.50 after a year.Future Value One way to look at this problem is to see whether you are able to invest the $1 today and get back more than $1. .

Future Value Using EXCEL function: .

.46 today Since $1. Assuming we could invest the money at 3%. the 1.50 (1+0.46 is much more than the $1.50 is worth: 1.03) = 1.Present Value We could also look at how much the $1.50 we will be getting in a year’s time is worth to us today. we should choose option B.

Present Value Using EXCEL function: .

FVt – Future Value.Basic Present Value Equation These are the equations we have been using: Compounding PV Discounting FV FVt = PV (1+r)t PV = FVt (1+r)t PV – Present Value. What future cash flows are worth today. rate of return. r . What cash flows are worth in the future.interest rate. discount rate per period t .number of periods .

Examples include: Student Loan Payments Insurance Premiums Perpetuities Annuities Unequal Cash Flows .Types of Cash Flows An annuity is a stream of constant cash flows that occur at regular intervals for a fixed period of time.

Types of Cash Flows To Calculate Present Value/Future Value. $500 $500 $500 $500 $500 Now Year 1 Year 2 Year 3 Year 4 Year 5 Annuity Due: Payments or receipts occur at the beginning of each period. . we can consider each individual Cash Flow and discount/compound it to the present/future value before adding it all together. Annuities Unequal Cash Flows Perpetuities Ordinary Annuity: Payments or receipts occur at the end of each period.

Ordinary Annuity (at end of each period) Using EXCEL function: Note: The default value of “Type” = 0. . Where the payment is made at the end of each period.

Annuity Due (at the beginning of each period) Using EXCEL function: Enter „1‟ for Type .

Annuities $500 $300 $200 $400 $100 Unequal Cash Flows Perpetuities Now Year 1 Year 2 Year 3 Year 4 Year 5 To Calculate Present Value/Future Value.Types of Cash Flows For unequal Cash Flows. . we can consider each individual Cash Flow and discount it to the present value/future value before adding it all together.

Unequal cash flows Using EXCEL function: .

Unequal cash flows Using EXCEL function: .

discount rate .Types of Cash Flows A perpetuity is an annuity that lasts forever. rate of return.interest rate. Annuities Unequal Cash Flows $500 $500 $500 $500 $500 Now Year 1 Year 2 Year 3 Year 4 Year 5 Perpetuities PV of Perpetuity = C r C – cash flow r .

Types of Cash Flows .Summary .

Application to Problem Statement .

• To assume interest to be compounded semi-annually .000) Reeback Ltd Ordinary Annuity (pay $4. Nikey Ltd One time present payment (upfront payment of $20.Solving the Problem • We will determine the present value and future value of each of the options.000.100.000 at the end of every six months) Xtreme Ltd One time future payment (pay at the end of three years) Embro Ltd Unequal cash flows (different payments as shown in Table 1) • To decide which option is more attractive. we have to make assumptions about the rate of return.

FV Calculation .

FV Calculation .

FV Calculation .

PV Calculation .

PV Calculation .

PV Calculation .

. But using either FV or PV will give the same conclusion for the same discount rate.Comparing the Options using different discount rates Future Value Present Value Different assumptions of discount rate made will result in different conclusions.

• Consider the current distribution channels.e. especially since the company is a young one.Other Considerations • Other factors affecting the cash flow such as the need to pay off loans that are due soon. • Other needs. the risks involved for each option especially for the sales forecast probability. • Consider the uncertainty of the cash flow i. . options that provide a cash flow upfront early may be more attractive. stability and financial reputation of the four companies.

Concept Diagram Simple or Compound? Cash flows Interest Time Value Of Money •Annuities •Unequal cash flows •Perpetuity Present Value Future Value .

) Retrieved October 10.com/articles/03/082703.A. New York: McGraw-Hill Irwin Reference Textbooks •Brealey.com website: http://www.J.. Westerfield. G. [Chapter 9] •Brigham.asp •NetMBA Business Knowledge Center.) New York: McGraw-Hill Irwin.com website: http://teachmefinance.).122-140 & Chapter 6. S.A. & Houston. (2008).) Retrieved October 10. Time Value of Money (Concise 4th ed..A. [Chapter 6] Websites •The Time Value of Money.. Myers. (n. Corporate Finance Fundamentals (8th ed.d. & Jordan.) [Chapter 5.d. from TeachMeFinance. (n. Foundations of Financial Management.com website: http://www. R.com/timevalueofmoney. E.) New York: McGraw-Hill Irwin. & Marcus A. R. (n.d. pp. Time Value of Money (5th ed. 2010 from netmba. pp. (2007). Fundamentals of Corporate Finance.F.netmba.W. B. (2008).com/finance .F..References Recommended Textbooks •Ross. 2010. S.investopedia.. (2007). J. from Investopedia. 2010.html •Understanding the Time Value of Money. [Chapter 4] •Block. 146-170]. Fundamentals of Financial Management. Thomson South-Western.) Retrieved October 10.B. Hirt.D.C. Time Value of Money (12th ed. S.

Sign up to vote on this title

UsefulNot useful- Module Time Pp t
- 1 - Tvm Concepts
- Module Time Pp t
- Time Value of Money
- fnan 301
- Financial Management Ch06
- 6. Present Value of an Annuity
- Time Value of Money
- Present Value of an Annuity
- Time Value of Money
- Understanding the Time Value of Money
- HW2 Solution FNCE 101
- LCBF_Time Value of Money
- The Time Value of Money
- unit-2%28complete%29
- Chap 009
- Module Time Pp t
- Investment Appraisal Method
- AppB - Time Value of Money (With Ch. 10)
- chap9
- Chapter 6
- cf2_1
- Time Value of Money
- Chapter 5 Time Value of Money.ppt
- CH_6_PPT
- Financial Mathematics for Actuaries
- Chapter_5
- Annuities
- 00001
- Annuities Calculation
- B320 BF06 Time Will Tell 6th Presentation 15Nov2010

Are you sure?

This action might not be possible to undo. Are you sure you want to continue?

We've moved you to where you read on your other device.

Get the full title to continue

Get the full title to continue reading from where you left off, or restart the preview.

scribd