Chapter 5

Time Value of Money

PV = Present Value FV = Future Value i = Interest Rate

Future value of $100 earning 10% interest in one year

FV = 100 + (100* .10) = $110

FV = PV + Interest

FV = PV + (PV * i)

Future value of 100 in two years earning 10% per year is

FV=[100+(100 * .10)] +[100 + (100 *.1)]*.10 = $121

FV =[ PV +( PV * i)] + [PV +(PV * i)]* i

FV = PV(1+i)(1+i)

FV = PV(1+i)(1+i)

FV = PV(1+i)N N= number of periods (years)

FV = $100 (1+.1)2

FV = 121

Financial Calculator - BA II PLUS

Calculate the future value of $100 in 2 years earning 10% interest per year

2nd FV (clears calculator of any numbers)

2ND I/Y 1 Enter CE/C (computes interest

on yearly basis)

2nd . 4 Enter CE/C (4 decimal places)

2 N (2 year period)

10 I/Y (10% interest rate)

- 100 PV (100 is the present value amount)

1
CPT FV (computes future value = 121)

1. If you deposit $10,000 in a bank account that pays 10 percent interest annually, how
much money will be in your account after 5 years?

Calculate FV of 10,000 in 10 years at 15%

a. How much is $150 invested at 12% for 1 year?

1 N
-150 PV
12 I/Y
CPT FV

b. Find the FV of $200 invested at 12% for 5 years (annual compounding) is

5 N
- 200 PV
12 I/Y
CPT FV

c. Find the FV of $10,000 invested for 10 years at 10% per year (semi- compounding).

10*2=20 N NxM = number of years x compounding periods per year

-10,000 PV
10/2 I/Y i/M = annual interest rate/compounding periods per year
CPT FV

d. How many years will it take to turn $100 into $1210 invested at 10% per year
(annual compounding)?

- 100 PV
10 I/Y
1210 FV
CPT N

2
Present Value - find the amount of money to invest today to have $1000 in 5 years if
the investment earns 10%.

PV = FV(1/1+i)N

PV = 1000(1/1+.1)5

PV = 1000(.62092) = $620.92

Financial Calculator

2nd FV (Clears calculator)

5 N ( 5 years)

10 I/Y (10% interest)

1000 FV (1000 in 5 years)

CPT PV (Finds present value amt=$620.92)

Find PV of $1,000,000 in 30 yrs at 15%

2. What is the present value of a security that promises to pay you $5,000 in 20 years?
Assume that you can earn 7 percent if you were to invest in other securities of equal risk.

e. How much must you invest today (PV) to have of $100 after 1 year invested at 12%
per year?
1 N
100 FV
12 I/Y
CPT PV

f. How much must you invest today (PV) to have $1000 after 5 years invested at
10% per year (annual compounding)?

5N

3
 1000 FV
10 I/Y
CPT PV

g. How much must you invest today to have $50 after 5 years earning 12% per year
(semi- compounding)?

50 FV
6 I/Y i/M = annual interest rate/compounding periods per year
10 N NxM = number of years x compounding periods per year

CPT PV

h. Suppose that you have $5,000 to invest today. What will it be worth in 5 years if
there is no inflation and you can earn 10 percent on your money?

RULE OF 72

72 / % = number of years to double

investment

If you earn 10% on your money per year, how long will it take to double your
investment?

72 / 10 = 7.2 years

If your investment doubles in 10 years, what return per year did you make.

3. If you deposit money today into an account that pays 6.5 percent interest, how long will it
take for you to double your money?

4
 ANNUITIES

Find the future value of four $100 payments made at the end of each year for four years if
you earn 10% per year.

FV = $100(1+.10)3 + $100(1+.10)2 +$100(1+.10)1 +$100

FV = $100[(1+.10)3 + (1+.10)2
+ (1+.10)1 + 1]

FV = $100(4.6410) = $464.10

FV = PMT [(1+i) N – 1] / i

Financial Calculator

2nd FV (clear calculator)

4 N (4 payments)

10 I/Y (10% interest)

- 100 PMT (100 payments)

CPT FV (Calculates future value = $464.10)

Find the present value of four $100 payments made at the end of each of the next four
years earning a return of 10% per year.

PV = 100(1/1+.1)1 + 100(1/1+.1)2 + 100(1/1+.1)3 + 100(1/1+.1)4 =

PV = 100[(1/1+.1)1 + (1/1+.1)2 +(1/1+.1)3 + (1/1+.1)4] = 100(3.1698) = $316.98

PV =∑ [ PMT / (1+i)N]

PV = PMT [(1 - (1/1+i)N ] / i

5
Financial Calculator

2nd FV (clears calculator)

4 N (4 payments)

10 I/Y (10% interest)

100 PMT ($100 payments)

CPT PV (calculates present value = 316.98)

4. What is the future value of a 5-year ordinary annuity that promises to pay you $300 each
year? The rate of interest is 7 percent.

A mortgage company offers to lend you $85,000; the loan calls for payments of
$8,273.59 per year for 30 years. What interest rate is the mortgage company charging
you?

TIME VALUE OF MONEY

PERPETUITIES

Find the present value of $100 payment made at the end of each and every year forever if
it earns 10% interest per year.

PV = 100 / .10 = 1000

PV (Perpetuity) = Payment / Interest Rate

5. What is the present value of a perpetuity of $100 per year if the appropriate discount rate
is 7 percent? If interest rates in general were to double and the appropriate discount rate
rose to 14 percent, what would happen to the present value of the perpetuity?

Multiple Uneven Cash flows

Future value of a 10%, 3-year cash flow:

Yr Cash flow
1 2000
2 1000

6
3 2000

An investment pays you $100 at the end of each of the next 3 years. The investment will
then pay you $200 at the end of Year 4, $300 at the end of Year 5, and $500 at the end of
Year 6. If the interest rate earned on the investment is 8 percent, what is its present value?
What is its future value?

Present value of a 10%, 3-year cash flow:

Yr Cash flow

1 1000
2 2000
3 1000

3313.30

BA II Plus

CF
2nd CE/C [Clears Calculator]
2nd . 4 Enter

CF [CFo=0.0000]
arrow down [C01 0.0000]
1000 Enter [C01 = 1000]
arrow down [F01= 1.000]
arrow down [C02 0.0000]
2000 Enter [C02= 2000]
arrow down [F02= 1.000]
arrow down [C03 0.0000]
1000 Enter [C03= 1000]
NPV [I = 0.00000]
10 Enter [I = 10.0000]
arrow down [NPV= 0.0000]
CPT [NPV= 3313.30]

7
 Practice: Multiple Uneven Cash Flows

Year Cash flows

0 0
1 43,332
2 45,976
3 35,928
4 54,964

CF
2nd CE/C [Clears Calculator]
2nd . 4 Enter

CF [CFo=0.0000]
arrow down [C01 0.0000]
43332 Enter [C01 = 43332]
arrow down [F01= 1.000]
arrow down [C02 0.0000]
45976 Enter [C02= 45976]
arrow down [F02= 1.000]
arrow down [C03 0.0000]
35928 Enter [C03= 35928]
arrow down [F03= 1.000]
arrow down [C04 0.0000]
54964 Enter [C04= 54964]
NPV [I = 0.00000]
10 Enter [I = 10.0000]
arrow down [NPV= 0.0000]
CPT [NPV= 141,923.8112]

Nominal (stated) annual interest rate or annual percentage rate (APR)

* The annual rate without considering the effect of compounding

Effective annual interest rate (EAR) or effective annual yield (EAY)

* The annual rate after considering the effect of compounding

EAR=APR if interest is compounded annually; otherwise, EAR > APR

8
 If APR is 10% compounded monthly, what is the EAR?

EAR = [(1+(i/m)]m – 1 = [(1+(.10/12)]12 –1 = .1047 10.47%

M = number of compounding periods
Amortizing a Loan –
Interest rate 9% Loan Amount $5000
5 Year Loan Paid at End of Each Year

Beginning Interest Principal Ending

Year Balance Payment Paid Paid Balance

1 $5,000.0 $1,285.46 $ 450.00 $ 835.46 $4,164.54

2 4,164.54 1,285.46 374.81 910.65 3,253.88
3 3,253.88 1,285.46 292.85 992.61 2,261.27
4 2,261.27 1,285.46 203.51 1,081.95 1,179.32
5 1,179.32 1,285.46 106.14 1,179.32 0.00

Totals $6,427.30 $1,427.31 $5,000.00

Payment Interest Principal Paid Ending Balance

5 N Beginning Balance Payment Beginning balance
9 I/Y Multiplied Times Less Less
- 5000 PV Interest Rate Interest Principal Paid
CPT PMT