TIME VALUE OF MONEY

SIMPLE SIMPLE
INTEREST DISCOUNT

TIME VALUE COMPOUND

OF MONEY INTEREST

EQUIVALENCE
SIMPLE INTEREST
When the total interest earned or charged is linearly proportional to the initial
amount of the loan (principal), the interest rate and the number of interest
periods for which the principal is committed, the interest and the interest rate
are said to be SIMPLE

𝐼 = 𝑃𝑖𝑁
P = principal amount lent or borrowed;
N = number of interest periods
i = interest rate per interest period
SIMPLE INTEREST
𝐹 = 𝑃(1 + 𝑖𝑁)
F = future worth;
P = principal amount lent or borrowed;
N = number of interest periods
i = interest rate per interest period
SIMPLE DISCOUNT
𝑖 1
d= d=1−
𝑃 1+𝑖
d = rate of discount; 𝑑
P = principal amount lent or borrowed; i=
1−𝑑
i = interest rate per interest period
SAMPLE PROBLEM

If ₱1000 accumulates to ₱1500

when invested at a simple
interest for three years, what is
the rate of interest?
SAMPLE PROBLEM
𝐹 = 𝑃(1 + 𝑖𝑁)
1500 = 1000(1 + 𝑖(3))

i= 0.1667 = 𝟏𝟔. 𝟔𝟕%

SAMPLE PROBLEM
You loan from a loan firm an amount of
₱100,000 with a rate of simple interest
of 20% but the interest was deducted
from the loan at the time the money was
borrowed. If at the end of one year, you
have to pay the full amount of ₱100,000,
what is the actual rate of interest?
 SAMPLE PROBLEM
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 0.20 100,000 = 20,000
𝐴𝑚𝑜𝑢𝑛𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 = 100,000 − 20,000 = 80,000
𝐼 = 𝑃𝑖𝑁
20,000 = 80,000(𝑖)(1)
𝒊 = 𝟐𝟓%
SAMPLE PROBLEM
Mr. J. Dela Cruz borrowed money
from a bank. He receives from the
bank ₱1,340 and promised to pay
₱1,500 at the end of 9 months.
Determine the corresponding
discount rate or often referred to as
the “banker’s discount”.
 SAMPLE PROBLEM
𝐹 = 𝑃(1 + 𝑖𝑁)
9
1500 = 1340(1 + 𝑖( ))
12
i= 0.1592 = 15.92%
1 1
d=1− =1− = 0.1373 = 𝟏𝟑. 𝟕𝟑%
1+𝑖 1 + 0.1592
COMPOUND INTEREST
In compound interest, the interest earned by the
principal at the end of each interest period
(compounding period) is added to the principal.
The sum (principal + interest) will earn another
interest in the next compounding period.
COMPOUND INTEREST
Consider $1000 invested in an account of 10% per year for 3 years.
At 10% simple interest, the $1000 investment amounted to $1300 after 3
years. Only the principal earns interest which is $100 per year.
COMPOUND INTEREST
At 10% compounded yearly, the $1000 initial investment amounted
to $1331 after 3 years. The interest also earns an interest.
COMPOUND INTEREST
Elements:
P = Principal, present amount
F = Future amount, compound amount
i = interest rate per compounding period
r = nominal annual interest rate
n = total number of compounding in t years
t = number of years
m = number of compounding per year
COMPOUND INTEREST
𝑟
𝑖= 𝑎𝑛𝑑 𝑛 = 𝑚𝑡
𝑚
i = interest rate per compounding period
r = nominal annual interest rate
n = total number of compounding in t years
t = number of years
m = number of compounding per year
COMPOUND INTEREST
𝑟 𝑛
𝐸𝑅 = (1 + ) −1
𝑚
ER = Effective rate
i = interest rate per compounding period
r = nominal annual interest rate
n = total number of compounding in t years
t = number of years
m = number of compounding per year
 COMPOUND INTEREST
𝑛
𝑟 𝑚𝑡
𝐹 = 𝑃(1 + 𝑖) 𝑜𝑟 𝐹 = 𝑃(1 + )
P = Principal, present amount
𝑚
F = Future amount, compound amount
i = interest rate per compounding period
r = nominal annual interest rate
n = total number of compounding in t years
t = number of years
m = number of compounding per year
𝑵𝒐𝒕𝒆: (𝟏 + 𝒊)𝒏 𝒊𝒔 𝒄𝒂𝒍𝒍𝒆𝒅 𝒔𝒊𝒏𝒈𝒍𝒆 − 𝒑𝒂𝒚𝒎𝒆𝒏𝒕 𝑪𝑶𝑴𝑷𝑶𝑼𝑵𝑫 𝑨𝑴𝑶𝑼𝑵𝑻 𝒇𝒂𝒄𝒕𝒐𝒓; 𝐃𝐞𝐧𝐨𝐭𝐞𝐝 𝐛𝐲 (𝐅|𝐏, 𝐢, 𝐧)
 COMPOUND INTEREST
𝐹
𝑃= 𝑛
(1 + 𝑖)
P = Principal, present amount
F = Future amount, compound amount
i = interest rate per compounding period
n = total number of compounding in t years
𝟏
𝑵𝒐𝒕𝒆: 𝒊𝒔 𝒄𝒂𝒍𝒍𝒆𝒅 𝒔𝒊𝒏𝒈𝒍𝒆 − 𝒑𝒂𝒚𝒎𝒆𝒏𝒕 𝑷𝑹𝑬𝑺𝑬𝑵𝑻 − 𝑾𝑶𝑹𝑻𝑯 𝒇𝒂𝒄𝒕𝒐𝒓; 𝐃𝐞𝐧𝐨𝐭𝐞𝐝 𝐛𝐲 (𝐏|𝐅, 𝐢, 𝐧)
(𝟏 + 𝒊)𝒏
COMPOUND INTEREST
𝐹
ln( )
𝑛= 𝑃
𝑙𝑛(1 + 𝑖)
P = Principal, present amount
F = Future amount, compound amount
i = interest rate per compounding period
n = total number of compounding in t years
COMPOUND INTEREST
𝑛 𝐹
𝑖= −1
𝑃
P = Principal, present amount
F = Future amount, compound amount
i = interest rate per compounding period
n = total number of compounding in t years
COMPOUND INTEREST
VALUES OF i AND n
In most problems, the number of years t and the number of compounding periods per
year m are given. The example below shows the value of i and n.
COMPOUND INTEREST
VALUES OF i AND n
COMPOUND INTEREST
CONTINUOUS COMPOUNDING (m ---> infinity)
COMPOUND INTEREST
CONTINUOUS COMPOUNDING (m ---> infinity)
SAMPLE PROBLEM
The amount of ₱20,000 was deposited
in a bank earning at interest of 6.5% per
annum. Determine the total amount at
the end of 7 years if the principal and
interest were not withdrawn during this
period.
SAMPLE PROBLEM
𝐹 = 𝑃(1 + 𝑖)𝑛

𝐹 = 20000(1 + .065)7

𝐹 = 31,079.73
SAMPLE PROBLEM

What nominal rate, compounded

semi-annually, yields the same
amount as 16% compounded
quarterly?
SAMPLE PROBLEM
𝐸𝑅1/2 = 𝐸𝑅1/4
𝑟 2 𝑟 4
(1 + ) −1 = (1 + ) −1
2 4
𝑟 2 0.16 4
(1 + ) = (1 + )
2 4
𝑟 = 16.32%
SAMPLE PROBLEM

₱1,500 was deposited in a bank

account, 20 years ago. Today, it is
worth ₱3,000. Interest is paid
semi-annually. Determine the
interest rate paid on this account.
SAMPLE PROBLEM
𝐹 = 𝑃(1 + 𝑖)𝑛
3000 = 20000(1 + 𝑖)2(20)
𝑖 = .0175
𝑟 𝑟
.0175 = =
𝑚 2
𝒓 = 𝟑. 𝟓%
ANNUITY
ANNUITY
An annuity is a series of equal payments made at equal intervals of time.
Financial activities like installment payments, monthly rentals, life-
insurance premium, monthly retirement benefits, are familiar examples of
annuity.
• Specific amount of payments are set
CERTAIN to begin and end at a specific length
of time
• The annuitant may be paid according
UNCERTAIN
to certain event
 ANNUITY
The payment period is the same
as the interest period, which
SIMPLE means that if the payment is
made monthly the conversion of
money also occurs monthly
CERTAIN
ANNUITY

The payment period is not the

GENERAL
same as the interest period
 ANNUITY

SIMPLE ANNUITY

ORDINARY ANNUITY DEFERRED

PERPETUITY
ANNUITY DUE ANNUITY
ANNUITY
ORDINARY ANNUITY
In ordinary annuity, the equal payments are made at the end of each
compounding period starting from the first compounding period.

From the cash flow diagram shown

above, the future amount F is the sum
of payments starting from the end of
the first period to the end of
the nth period. Observe that the total
number of payments is n and the total
number of compounding periods is
also n. Thus, in ordinary annuity, the
number of payments and the number
of compounding periods are equal.
ANNUITY
ORDINARY ANNUITY

𝐴 (1 + 𝑖)𝑛 − 1
𝐹=
𝑖

(1+𝑖)𝑛 −1
The factor is called EQUAL-PAYMENT-SERIES COMPOUND-AMOUNT
𝑖
FACTOR and is denoted by (F/A,I,n). The reciprocal is called the EQUAL-PAYMENT-
SERIES SINKING FUND FACTOR and is denoted by (A/F,I,n).
ANNUITY
ORDINARY ANNUITY

𝐹 𝐴 (1 + 𝑖)𝑛 − 1
𝑃= 𝑛
=
(1 + 𝑖) (1 + 𝑖)𝑛 𝑖

(1+𝑖)𝑛 −1
The factor 𝑛 is called EQUAL-PAYMENT-SERIES PRESENT-WORTH
(1+𝑖) 𝑖
FACTOR and is denoted by (P/A,i,n). The reciprocal is called the EQUAL-
PAYMENT-SERIES CAPITAL-RECOVERY FACTOR and is denoted by (A/P,i,n).
ANNUITY
ORDINARY ANNUITY

𝐹 𝐴 (1 + 𝑖)𝑛 − 1
𝑃= 𝑛
=
(1 + 𝑖) (1 + 𝑖)𝑛 𝑖

(1+𝑖)𝑛 −1
The factor 𝑛 is called EQUAL-PAYMENT-SERIES PRESENT-
(1+𝑖) 𝑖
WORTH FACTOR and is denoted by (P/A,i,n)
ANNUITY
ANNUITY DUE
In annuity due, the equal payments are made at the beginning of each
compounding period starting from the first period.

F1 is the sum of ordinary annuity

of n payments. The future
amount F of annuity due at the end
of nth period is one compounding
period away from F1.
ANNUITY
ANNUITY DUE

𝐴 (1 + 𝑖)𝑛 − 1
𝐹 = 𝐹1 1 + 𝑖 = (1 + 𝑖)
𝑖
𝑛
𝐹1 𝐴 (1 + 𝑖) − 1
𝑃= = (1 + 𝑖)
(1 + 𝑖)𝑛 (1 + 𝑖)𝑛 𝑖
ANNUITY
DEFERRED ANNUITY
In deferred annuity the first payment is deferred a certain number of compounding periods after
the first. In the diagram below, the first payment was made at the end of the kth period
and n number of payments was made. The n payments form an ordinary annuity
ANNUITY
DEFERRED ANNUITY

𝑛
𝐴 (1 + 𝑖) − 1
𝐹=
𝑖

𝐹 𝐴 (1 + 𝑖)𝑛 − 1
𝑃= =
(1 + 𝑖)𝐾+𝑛 (1 + 𝑖)𝐾+𝑛 𝑖
ANNUITY
PERPETUITY
Perpetuity is an annuity where the payment period extends forever,
which means that the periodic payments continue indefinitely.

There is no definite
future in perpetuity,
thus, there is no
formula for the future
amount
ANNUITY
PERPETUITY
𝑛 𝑛
𝐴 (1 + 𝑖) − 1 𝐴 (1 + 𝑖) 𝐴
𝑃= = −
(1 + 𝑖)𝑛 𝑖 (1 + 𝑖)𝑛 𝑖 (1 + 𝑖)𝑛 𝑖
𝐴 𝐴
𝑃= −
𝑖 (1 + 𝑖)𝑛 𝑖 When ninfinity,
𝐴 𝐴 𝐴
𝑃= − 𝑃=
𝑖 (1 + 𝑖)𝑛 𝑖 𝑖