The Time Value of Money
n = Number of periods
i = Interest rate per period
PV = Present Value
PMT = Payment
FV= Future Value
Interest is the return earned by or the amount paid to someone who has forgone current
consumption or alternative investment opportunities and “rented” money in a creditor
relationship. The principal is the amount of money borrowed or invested. The term of loan is the
length or number of time periods during which the borrower can use the principal. The rate of
interest is the percentage on the principal that the borrower pays the lender per time period as
compensation for foregoing other investment or consumption opportunities.
SIMPLE INTEREST : I = PV x i x n
What is the simple interest on P100.00 at 10% per annum for six months?
I = P100.00 x 0.10 x 6/12 ; I = P5.00
If Pepe borrowed P30,000.00 to buy a cellular phone at 10% annual interest rate, what would be
his first month’s interest payment?
I = P30,000.00 x 0.10 x 1/12 ; I = P250.00
If Pilar receives P30.00 every three (3) months from a bank that pays 6% annual interest, how
much did she invest?
PV = I/I x n ; PV = P30.00/.06 x .25 ; PV = P2, 000.00
COMPOUND INTEREST : FV = PV (1 + i)
Compound interest is interest that is paid not only on the principal but also any interest earned
but not withdrawn during earlier periods.
If Jose leaves P1,000.00 plus accumulated interest in the account for another year at 6% per
annum, the computation would be :
FV = FV ( 1 = i) ; FV = P1,060. 00 x (1 + .06) ; FV = P1,123.60
Investment is now P1,123,60 at the end of the second year, as opposed to only P1,120.00 if the
interest of P 60.00 for the first year had been withdrawn. The said interest became part of the
principal and also earned interest on the second year.
To simplify, use Table 1. n= 2 and i= 6% intersect at the value 1.124.
Therefore, FV = PV (1.124) ; P1,000.00 (1.124) = P1,124.00 which approximates P1,123.60.
Supposing Mila invest P1,000.00 in a paluwagan at 6% for twenty years. What will be the
amount withdrawable at the end of the period?
FV = P1,000.00 (3.207) ; FV = P3,207.00
How long will it take for P1,000.00 invested at 8% to double
FV = PVo (PVIF) ; FVIF = FV/PVo ; FVIF = P2,000.00/P1,000.00 ; FVIF= 2.000
Looking at Table 1, the column on 8% interest showing the value closest to 2.000 is 1.999 and is
at n=9. Therefore, P1,000.00 can become P2,000.00 at 8% interest compounded yearly in 9
years.
Present value and future value relationship
What is the present value of P1,000.00 received 20 years in the future discounted at 10%?
PV = FV20 (PVIF) Using table 2 , PV = P1,000.00 (.149) ; PV = P149.00
Your P149.00 invested today at 10% compounded annually for 20 years would be worth
P1,000.00 at the end of the period. Conversely the promise to pay P1,000.00 in 20 years is worth
P149.00 today given a 10% interest rate.
Interpolation : If you borrow money today amounting to P5,000.00 from a cooperative and
promise to pay P6,250 in four years, what is the implied interest rate?
PVo = FV 4 (PVIF) ; P5,000.00 = P6,250.00 (PVIF) ; PVIF = P5,000.00/P6,250.00
PVIF = .8000
Using Table 2 where n = 4, the value 0.800 is found between 5% (0.823) and 6% (0.792)
i = 5% + .823-.800 / .823-.792 (1%) = 5.74%
Annuity is the payment or receipt of equal cash flows per period for a specified amount of time.
An ordinary annuity is one which the payments or receipts occur at the end of each period. An
annuity due is one in which payments or receipts occur at the beginning of each period.
Juan gets P1,000.00 per year and deposits the same at the end of each year. If the interest rate is
6%, how much will he have at the end of three (3) years?
Y3 = P1,000.00 ; Y2 = P1,000.00 (1 + .06) = 1,060.00 ; Y1 = 1,000.00 (1+.06)2 = P1,124.00
Total = P3,184.00
Using Table 3, the intersection of i=6% and n=3 is 3.184 FVAN = PMT (FVIFA)
FVAN = P1,000.00 (3.184) = P3,184.00
This is useful in preparing for a maturing long term loan.
Example: P5,000,000.00 loan to be paid in 5 years. Interest in investment is 9.5%
How much should you invest each year to prepare to pay the long term loan?
FVAN = P5,000,000.00 i =9.5% n=5 ; FVAN = PMT [(1+.095)5 -1) /.095]
PMT = FVAN/ [(1+.095)5 -1) /.095] ; PMT = P827,182.00
By investing P827,182.00 at the end of each year for the next 5 years with ah interest of 9.5%, ,
the owner can raise the amount of P5,0000,000.00 to pay the loan upon maturity.
Use of Table 4: Solving for interest rate. Your company buys a machine worth P100,000.00 with
expected cash flows of P26,378.00 for you in the next five years. What is the interest rate?
PVAN = PMT (PVIFA ) ; P100,000.00 = P26,378.00 (PVIFA) ; PVIFA = 3.791
Using table 4, n=5 and PVIFA = 3.791 shows that the interest rate is 10%.
Loan Amortization
Example : You borrowed P10,000.00 from your best friend payable in 4 years at 9% interest
PVAN = PMT (PVIFA) ; P10,000.00 = PMT (3.240) ; PMT = P3,086.42
Amortization Schedule :
End of year Payment Interest Principal Remaining
Reduction Balance
0 10,000.00
1 3,087.00 900 2,187 7,813.00
2 3,087.00 703 2,384 5,429.00
3 3,087.00 489 2,598 2,831.00
4 3,087.00 255 2,832 0
Interest = Remaining balance x interest rate (9.0%)
Principal reduction = Payment – Interest
Remaining balance = Remaining balance less – principal reduction
Total payments = 3,087.00 x 4 = P 12,348.00
Effective interest for four years = P2,348.00
